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Sohei Kaihatsu Takushi Kurozumi Monetary Affairs Department, Bank of Japan

Sohei Kaihatsu Takushi Kurozumi Monetary Affairs Department, Bank of Japan. Sources of Business Fluctuations: Financial or Technology Shocks?. Central Bank Macroeconomic Modeling Workshop Manila, Philippines October 20, 2010.

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Sohei Kaihatsu Takushi Kurozumi Monetary Affairs Department, Bank of Japan

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  1. Sohei KaihatsuTakushi KurozumiMonetary Affairs Department, Bank of Japan Sources of Business Fluctuations: Financial or Technology Shocks? Central Bank Macroeconomic Modeling Workshop Manila, Philippines October 20, 2010 The views expressed herein are those of the authors and should not beinterpreted as those of the Bank of Japan.

  2. Business Fluctuations What is the source of economic fluctuations? Level of output Growth Trend Time Kaihatsu and Kurozumi, Bank of Japan

  3. Question Addressed • In the business cycle literature, technology shocks have been considered the main source of business fluctuations. • However, the recent severe economic downturn caused by the collapse of credit bubbles seems to suggest the importance of financial shocks. Which is the major source of business fluctuations, financial or technology shocks? Kaihatsu and Kurozumi, Bank of Japan

  4. Answer: Our Empirical Findings • In both U.S. and Japan, the major driving forces of output fluctuations are technology shocks. • In particular, neutral technology shocks are the major source of output fluctuations. • Financial shocks are at least as important for investment fluctuations as technology shocks. • External finance premium shows a sharp decline and a subsequent hike, and thereby induce the boom and bust cycles of investment. Kaihatsu and Kurozumi, Bank of Japan

  5. Our Approach • Financial accelerator mechanism of Bernanke, Gertler, and Gilchrist [BGG] (1999). • DSGE model with stochastic trends in neutral and investment-specific technological changes. • Bayesian estimation with economic and financial data of U.S. and Japan. Kaihatsu and Kurozumi, Bank of Japan

  6. Related Studies Kaihatsu and Kurozumi, Bank of Japan

  7. Investment efficiency shocks in U.S. • Justiano, Primiceri, and Tambalotti (2010b): • Introduce stochastic trends in neutral and investment-specific technological changes. • DSGE model for non-stationary variables, which grows at rates given by stochastic trends in neutral and investment-specific technological changes. • Use data on the relative price of investment good in their estimation to identify investment-specific technology shock. Kaihatsu and Kurozumi, Bank of Japan

  8. Investment efficiency shocks in U.S.(cont.) Level of output Stochastic Growth Trend Time Technological Changes Kaihatsu and Kurozumi, Bank of Japan

  9. Investment efficiency shocks in U.S.(cont.) • Justiano, Primiceri, and Tambalotti (2010b): • Investment fluctuations are driven mainly by shocks to the marginal efficiency of investment. • Estimated investment efficiency shocks correlate with credit spreads, and thus capture financial conditions for investment. Kaihatsu and Kurozumi, Bank of Japan

  10. Investment efficiency shocks in Japan • Hirose and Kurozumi (2010): • Use a similar approach to that of Justiano et al. (2010b). • Investment fluctuations are driven mainly by investment efficiency shocks. • Estimated investment efficiency shocks correlate strongly with the D.I. for firms’ financial position. Thus, the shocks are interpreted as the tightness of firms’ financing. Kaihatsu and Kurozumi, Bank of Japan

  11. Financial Shocks in a Financial Accelerator Mechanism • Gilchrist, Ortiz, and Zakrasek (2009): • A BGG-type financial accelerator is incorporated into Smets-Wouters (2007) model. • Investment efficiency shocks are removed, and two financial condition shocks are introduced: • External finance premium shock • Net worth shock • The financial accelerator mechanism is operative in U.S. business cycles. Kaihatsu and Kurozumi, Bank of Japan

  12. Our Contribution • Financial accelerator mechanism of BGG (1999), together with the two types of financial shocks instead of investment efficiency shock. • DSGE model for non-stationary variables, which grow at rates given by stochastic trends in neutral and investment-specific technological changes. • Bayesian estimation with economic and financial data, including the data on the relative price of investment good. Kaihatsu and Kurozumi, Bank of Japan

  13. The Model Kaihatsu and Kurozumi, Bank of Japan

  14. Outline of the Model External Finance Capital Entrepreneur Production Financial Intermediary Retailer Capital-Good Firm Labor Investment Retailing Deposit Household Consumption-Good Firm Investment-Good Firm Consumption Production Monetary Policy Net Export Government Central Bank Kaihatsu and Kurozumi, Bank of Japan

  15. Outline of the Model Net worth shock External Finance Capital Entrepreneur Financial Accelerator External finance premium shock Investment Trend Production Financial Intermediary Retailer Capital-Good Firm Labor Investment Retailing Deposit Household Consumption-Good Firm Investment-Good Firm Consumption Production Investment-specific technology shock Monetary Policy Net Export Government Central Bank Kaihatsu and Kurozumi, Bank of Japan

  16. Outline of the Model Net worth shock Neutral technology shock External Finance Capital Entrepreneur External finance premium shock Production Retailers’ markup shock Financial Intermediary Retailer Capital-Good Firm Labor Investment Retailing Deposit Wage markup shock Household Consumption-Good Firm Investment-Good Firm Consumption Production Investment-specific technology shock Investment-good price markup shock Monetary Policy Preferences shock Net Export Government Central Bank Exogenous demand shock Monetary policy shock Kaihatsu and Kurozumi, Bank of Japan

  17. External Finance Premium The real borrowing rate is External finance premium Entrepreneurs’ leverage ratio • External finance premium shock boosts the external finance premium beyond the level warranted by the current economic conditions. Policy rate External finance premium shock Kaihatsu and Kurozumi, Bank of Japan

  18. Estimation Strategy Kaihatsu and Kurozumi, Bank of Japan

  19. Estimation Strategy • Rewrite the equilibrium conditions in terms of stationary variables detrended by neutral and investment-specific technological changes. • Log-linearize the equilibrium conditions represented in terms of detrended variables. • Estimate the system of the log-linearized equilibrium conditions by Bayesian likelihood approach. Kaihatsu and Kurozumi, Bank of Japan

  20. Ten Shocks Kaihatsu and Kurozumi, Bank of Japan

  21. Ten Quarterly Time Series Sample periods: U.S. 1985:1Q-2008:4Q Japan 1981:1Q-1998:4Q Kaihatsu and Kurozumi, Bank of Japan

  22. Measurement Equations Investment-specific technology shock Balanced growth rate Kaihatsu and Kurozumi, Bank of Japan

  23. Empirical Analysis Parameter Estimates Historical/Variance Decompositions External Finance and Boom-Bust Cycles Kaihatsu and Kurozumi, Bank of Japan

  24. Parameter Estimates: U.S. Kaihatsu and Kurozumi, Bank of Japan

  25. Parameter Estimates: Japan Kaihatsu and Kurozumi, Bank of Japan

  26. Empirical Analysis Parameter Estimates Historical/Variance Decompositions External Finance and Boom-Bust Cycles Kaihatsu and Kurozumi, Bank of Japan

  27. Historical Decomposition of U.S.Output Growth Kaihatsu and Kurozumi, Bank of Japan

  28. Historical Decomposition of U.S.Investment Growth Kaihatsu and Kurozumi, Bank of Japan

  29. Variance Decompositions: U.S. Neutral technology External finance premium Kaihatsu and Kurozumi, Bank of Japan

  30. Historical Decomposition of Japan’s Output Growth Kaihatsu and Kurozumi, Bank of Japan

  31. Historical Decomposition of Japan’s Investment Growth Kaihatsu and Kurozumi, Bank of Japan

  32. Variance Decompositions: Japan Neutral technology External finance premium Kaihatsu and Kurozumi, Bank of Japan

  33. Empirical Analysis Parameter Estimates Historical/Variance Decompositions External Finance and Boom-Bust Cycles Kaihatsu and Kurozumi, Bank of Japan

  34. The Estimated External Finance Premium in the U.S. Kaihatsu and Kurozumi, Bank of Japan

  35. Historical Decomposition of U.S.External Finance Premium Kaihatsu and Kurozumi, Bank of Japan

  36. The Estimated External Finance Premium in Japan Kaihatsu and Kurozumi, Bank of Japan

  37. Historical Decomposition of Japan’s External Finance Premium Kaihatsu and Kurozumi, Bank of Japan

  38. The External Finance Premium and the Real Borrowing in U.S. Dot-com bubble Housing bubble Kaihatsu and Kurozumi, Bank of Japan

  39. The External Finance Premium and the Real Borrowing in Japan Asset price bubble Kaihatsu and Kurozumi, Bank of Japan

  40. Concluding Remarks Kaihatsu and Kurozumi, Bank of Japan

  41. Concluding Remarks • In both U.S. and Japan, neutral technology shocks are the main driving force of output fluctuations. • Financial shocks are at least as important for investment fluctuations as technology shocks. • External finance premium shows a sharp decline and a subsequent hike, and thereby induce the boom and bust cycles of investment. Kaihatsu and Kurozumi, Bank of Japan

  42. Future Direction of the Research • Concerning sources of boom and bust cycles, recent studies such as Christiano et al. (2010) emphasize the role of news or anticipated shocks about future technological changes. • Which is the major source of boom and bust cycles, financial or technology news shocks? Kaihatsu and Kurozumi, Bank of Japan

  43. End of Slides, Thank you. Kaihatsu and Kurozumi, Bank of Japan

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