Sources of Business Fluctuations

Financial or Technology Shocks?

December 2010
Sohei Kaihatsu ^*1
Takushi Kurozumi ^*2

Abstract

Despite the widespread belief that technology shocks are the main source of business fluctuations, recent empirical studies find that an investment efficiency shock mainly drives such fluctuations and reflects financial conditions for investment. This poses the question as to what is the major source of the fluctuations, financial or technology shocks. We thus incorporate a financial accelerator mechanism into a DSGE model with stochastic trends in neutral and investment-specific technological changes, and replace the investment efficiency shock with two financial shocks to the external finance premium and to entrepreneurs' net worth. This model is estimated by Bayesian methods with data including the relative price of investment and credit growth. We show that, in both Japan and the U.S., the main driving force of output fluctuations is neutral technology shocks, and financial shocks are at least as important for investment fluctuations as technology shocks. We also show that a sharp decline and a subsequent hike in the external finance premium, caused by shocks to this premium, induced the boom and bust cycles of investment via the financial accelerator mechanism during the late 1980s and the 1990s in Japan and since 2004 in the U.S.

Keywords
Business fluctuations; Financial accelerator; Trend in technological changes; External finance premium; Boom and bust cycle

JEL classification
E22; E32; E51

The authors are grateful for valuable comments from Kosuke Aoki, Dennis Botman, Hiroshi Fujiki, Ippei Fujiwara, Marvin Goodfriend, Luca Guerrieri, Naohisa Hirakata, Wataru Hirata, Yasuo Hirose, Hibiki Ichiue, Hirokazu Ishise, Michel Juillard, Ryo Kato, Nobuhiro Kiyotaki, Douglas Laxton, Paul McNelis, Masao Ogaki, Arito Ono, Masashi Saito, Toshitaka Sekine, Yuhei Shimizu, Shigenori Shiratsuka, Jae Sim, Penelope Smith, Nao Sudo, Yuki Teranishi, and Toshiaki Watanabe, as well as participants at the 2010 Central Bank Macroeconomic Modeling Workshop and the IMES Brown Bag Seminar. Any remaining errors are the sole responsibility of the authors. The views expressed herein are those of the authors and should not be interpreted as those of the Bank of Japan.

*1 Monetary Affairs Department, Bank of Japan
E-mail : souhei.kaihatsu@boj.or.jp
*2 Monetary Affairs Department, Bank of Japan
E-mail : takushi.kurozumi@boj.or.jp

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