Working Paper: NBER ID: w12647
Authors: Lawrence J. Christiano; Joshua M. Davis
Abstract: Using 'business cycle accounting' (BCA), Chari, Kehoe and McGrattan (2006) (CKM) conclude that models of financial frictions which create a wedge in the intertemporal Euler equation are not promising avenues for modeling business cycle dynamics. There are two reasons that this conclusion is not warranted. First, small changes in the implementation of BCA overturn CKM's conclusions. Second, one way that shocks to the intertemporal wedge impact on the economy is by their spillover effects onto other wedges. This potentially important mechanism for the transmission of intertemporal wedge shocks is not identified under BCA. CKM potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.
Keywords: Business Cycle Accounting; Financial Frictions; Intertemporal Wedge
JEL Codes: C01; C32; C52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| intertemporal wedge (D15) | output (C67) |
| financial shocks (F65) | intertemporal wedge (D15) |
| financial shocks (F65) | other wedges (Y90) |
| intertemporal wedge (D15) | consumption and investment (E20) |
| intertemporal wedge (D15) | output reductions (E23) |