Working Paper: CEPR ID: DP3581
Authors: Berthold Herrendorf; Kos Valentinyi
Abstract: It is well known that if there are mild sector-specific externalities, then the steady state of the standard two-sector real business cycle model can become locally indeterminate and endogenous business cycles can arise. We show that this result is not robust to the introduction of standard intertemporal capital adjustment costs, which may accrue when total capital is adjusted or when each sector?s capital is adjusted. We find for both forms of adjustment costs that the steady state is determinate for all empirically plausible parameter values. We also find that determinacy occurs for a much larger range of parameter values when adjusting each sector?s capital is costly.
Keywords: capital adjustment costs; determinacy; local indeterminacy; local stability; sector-specific externality
JEL Codes: E00; E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital adjustment costs (G31) | Local indeterminacy (D89) |
| Sectoral capital adjustment costs (D24) | Local indeterminacy (D89) |
| Total capital adjustment costs (G31) | Local indeterminacy (D89) |
| Capital adjustment costs (G31) | Steady state determination (C62) |
| Sectoral capital adjustment costs (D24) | Steady state determination (C62) |
| Total capital adjustment costs (G31) | Steady state determination (C62) |