Working Paper: CEPR ID: DP6113
Authors: Martin Flodn
Abstract: This paper demonstrates that increased optimism about future productivity can generate an immediate economic expansion in a neoclassical model with vintage capital and variable capacity utilization. Previous research has documented that standard neoclassical models cannot generate a simultaneous increase in consumption, investment, and hours in response to news shocks, and that optimism in these models tends to reduce investment and hours. When technology is vintage specific, however, expectations of higher future productivity raise the demand for new vintages of capital relative to installed capital. Capital depreciates faster when utilization is high, but this depreciation only affects installed capital. The cost of high depreciation therefore falls when the value of installed capital falls. It is demonstrated here that with standard parameter values, more optimism raises utilization, consumption, investment, hours, and output.
Keywords: business cycles; capital-embodied technological change; expectations; news; vintage capital
JEL Codes: E13; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased optimism about future productivity (O49) | economic expansion (F43) |
| increased optimism about future productivity (O49) | demand for new vintages of capital (D25) |
| demand for new vintages of capital (D25) | consumption (E21) |
| demand for new vintages of capital (D25) | investment (G31) |
| demand for new vintages of capital (D25) | hours worked (J22) |
| increased optimism about future productivity (O49) | overall output (E23) |
| greater optimism (P27) | simultaneous increase in consumption and investment (E20) |
| higher capital utilization (G31) | increased current utilization of existing capital (E22) |
| expectations of higher future productivity (O49) | increased current utilization of existing capital (E22) |
| EDBC can be generated under specific conditions (C68) | economic variables (P42) |