Volatility and growth: Credit constraints and the composition of investment
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CitationAghion, Philippe, George-Marios Angeletos, Abhijit Banerjee, and Kalina Manova. 2010. “Volatility and Growth: Credit Constraints and the Composition of Investment.” Journal of Monetary Economics 57 (3) (April): 246–265.
AbstractThis paper examines how uncertainty and credit constraints aﬀect the cyclical composition of investment and thereby volatility and growth. We develop a model where ﬁrms engage in two types of investment: a short-term one; and a long-term one, which contributes more to productivity growth. Because it takes longer to complete, long-term investment has a relatively less cyclical return; but it also has a higher liquidity risk. The ﬁrst eﬀect ensures that the share of long-term investment to total investment is countercyclical when ﬁnancial markets are perfect; the second implies that this share may turn procyclical when ﬁrms face tight credit constraints. The contribution of the paper is thus to identify a novel propagation mechanism: through its eﬀect on the cyclical composition of investment, tighter credit can lead to both higher volatility and lower mean growth. Evidence from a panel of countries provides support for the model’s key predictions.
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