Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment

Philippe Aghion, George-Marios Angeletos (), Abhijit Banerjee and Kalina Manova

No 11349, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We examine how credit constraints affect the cyclical behavior of productivity-enhancing investment and thereby volatility and growth. We first develop a simple growth model where firms engage in two types of investment: a short-term one and a long-term productivity-enhancing one. Because it takes longer to complete, long-term investment has a relatively less procyclical return but also a higher liquidity risk. Under complete financial markets, long-term investment is countercyclical, thus mitigating volatility. But when firms face tight credit constraints, long-term investment turns procyclical, thus amplifying volatility. Tighter credit therefore leads to both higher aggregate volatility and lower mean growth for a given total investment rate. We next confront the model with a panel of countries over the period 1960-2000 and find that a lower degree of financial development predicts a higher sensitivity of both the composition of investment and mean growth to exogenous shocks, as well as a stronger negative effect of volatility on growth.

JEL-codes: E22 E32 O16 O30 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dev and nep-mac
Date: 2005-05
Note: EFG
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