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Volatility and growth: credit constraints and productivity-enhancing investment

Aghion, P.; Angeletos, G.-M.; Banerjee, A.; Manova, K.; (2005) Volatility and growth: credit constraints and productivity-enhancing investment. (NBER Working Papers 11349). National Bureau of Economic Research: Cambridge, US. Green open access

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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.

Type: Working / discussion paper
Title: Volatility and growth: credit constraints and productivity-enhancing investment
Open access status: An open access version is available from UCL Discovery
Publisher version: http://www.nber.org/papers/w11349
Language: English
UCL classification: UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/17778
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