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Volatility and growth: Credit constraints and the composition of investment

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

Journal of Monetary Economics, 2010, vol. 57, issue 3, 246-265

Abstract: How does uncertainty and credit constraints affect the cyclical composition of investment and thereby volatility and growth? This paper addresses this question within a model where firms engage in two types of investment: a short-term one; and a long-term one, which contributes more to productivity growth. Because it takes longer to complete, long-term investment has a relatively less cyclical return; but it also has a higher liquidity risk. The first effect ensures that the share of long-term investment to total investment is countercyclical when financial markets are perfect; the second implies that this share may turn procyclical when firms face tight credit constraints. A novel propagation mechanism thus emerges: through its effect on the cyclical composition of investment, tighter credit can lead to both higher volatility and lower mean growth. Evidence from a panel of countries provides support for the model's key predictions.

Keywords: Growth; Volatility; Credit; constraints; Liquidity; Business; cycles; Amplification (search for similar items in EconPapers)
Date: 2010
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