Working Paper: NBER ID: w18217
Authors: Zhiguo He; Péter Kondor
Abstract: We develop a dynamic model of trading and investment with limited aggregate resources to study investment cycles. Unverifiable idiosyncratic investment opportunities imply market prices to play a role of rent distribution, distorting private investment incentives from a social point of view. This distortion is price-dependent, leading to two-sided inefficient investment cycles--too much investment in booms with high prices and too little in recessions with low prices. Interventions targeting only the underinvestment in recessions might make all agents worse off. We connect our results to both industry specific and aggregate boom-and-bust patterns.
Keywords: Investment Cycles; Financing Frictions; Pecuniary Externalities
JEL Codes: E22; E32; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Unverifiable idiosyncratic investment opportunities (D89) | Distortions in investment incentives (H32) |
| Distortions in investment incentives (H32) | Overinvestment during booms (E22) |
| Distortions in investment incentives (H32) | Underinvestment during downturns (G31) |
| Interventions aimed at mitigating underinvestment in downturns (E22) | Exacerbate overinvestment in booms (E22) |
| Interventions aimed at mitigating underinvestment in downturns (E22) | Worse outcomes in boom periods (E32) |
| Market conditions (D49) | Investment behavior (G11) |