Financial frictions and the role of investment-specific technology shocks in the business cycle

Shocks affecting the rate at which investment goods are transformed into capital stock have been identified as a major driver of the business cycle. Such shocks have been linked to frictions in financial markets, because financial markets are instrumental in transforming consumption goods into installed capital. Yet we show that the importance of these investment shocks is greatly diminished when collateral constraints on firms are introduced into an estimated dynamic stochastic general equilibrium model. In the presence of binding collateral constraints, risk premium shocks take on a more prominent role as drivers of the business cycle. Modellers of business cycle fluctuations need to be mindful of the incompatibility of investment shocks and collateral constraints and of the difficulty in specifying `structural' shocks that are robust to modest amendments to the frictions present in a model

Commodity prices and labour market dynamics in small open economies

We investigate the connection between commodity price shocks and unemployment in advanced resource-rich small open economies from an empirical and theoretical perspective. Shocks to commodity prices are shown to influence labour market conditions primarily through the real exchange rate contrasting sharply with the transmission of technology shocks which are typically argued to affect the economy by changing labour productivity. The empirical impact of commodity price shocks is obtained from estimating a panel vector autoregression; a positive price shock is found to be expansionary for the components of GDP, causes the real exchange rate to appreciate, and improves labour market conditions. For every one percent increase in commodity prices, our estimates suggest a one basis point decline in the unemployment rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse responses to a commodity price shock from a small open economy model with net commodity exports and search and matching frictions in the labour market to these empirical responses. As in the data, an increase in commodity prices raises consumption demand in the small open economy and induces a real appreciation. Facing higher relative prices for their goods, non-commodity producing firms post additional job vacancies, causing the number of matches between firms and workers to rise. As a result, unemployment falls, even if employment in the commodity-producing sector is negligible. For commodity price shocks, there is little difference between the standard Diamond (1982), Mortensen (1982), and Pissarides (1985) approach of modelling search and matching frictions and the alternating offer bargaining model suggested by Hall and Milgrom (2008)

News-driven business cycles in small open economies

The focus of this paper is on news-driven business cycles in small open economies. We make two significant contributions. First, we develop a small open economy model where the presence of financial frictions permits the replication of business cycle co-movements in response to news shocks. Second, we use VAR analysis to identify news shocks using data on four advanced small open economies. We find that expected shocks about the future Total Factor Productivity generate business cycle co-movements in output, hours, consumption and investment. We also find that news shocks are associated with countercyclical current account dynamics. Our findings are robust across a number of alternative identification schemes

Skilled migration and business cycle dynamics

Shocks to net migration matter for the business cycle. Using a structural vector autoregression and an estimated dynamic stochastic general equilibrium (DSGE) model of a small open economy, we find that migration shocks make an important contribution to the volatility of per capita GDP. Migration shocks contribute to variability in per capita consumption and investment, and to residential investment and real house prices. Despite the role of migration, other shocks remain more important drivers of these expenditure components and of housing market volatility. In the DSGE model, the level of human capital possessed by migrants relative to that of locals materially affects the business cycle impact of migration. The impact of migration shocks is larger when migrants have substantially different levels of human capital relative to locals. When the average migrant has more human capital than locals, as seems to be common for migrants into developed economies, a migration shock has an expansionary effect on per capita GDP and its components

News-driven business cycles in small open economies

The focus of this paper is on news-driven business cycles in small open economies. We make two significant contributions. First, we develop a small open economy model where the presence of financial frictions permits the replication of business cycle co-movements in response to news shocks. Second, we use VAR analysis to identify news shocks using data on four advanced small open economies. We find that expected shocks about the future Total Factor Productivity generate business cycle co-movements in output, hours, consumption and investment. We also find that news shocks are associated with countercyclical current account dynamics. Our findings are robust across a number of alternative identification schemes

The anatomy of small open economy productivity trends

We estimate a novel empirical (state-space) model to study the effects of international and domes- tic technology trend shocks on the UK economy. We jointly identify anticipated and unanticipated domestic and international technological innovations arising from changes in total factor productivity (TFP) and investment specific technology (IST). The long-run restrictions used to jointly identify the structural trends in the data are informed by a standard two-country structural model. Our results point to large and persistent swings in productivity. International non-stationary TFP and IST shocks explain about 30% and 24% of the variance of UK GDP, respectively. UK-specific TFP and IST shocks are somewhat less important, but still a relevant factor. Notably, it is the anticipated components of these international and domestic productivity shocks, rather than their unanticipated counterparts, which account for the bulk of the volatility in the data. We dissect the historical role of different shocks as drivers of UK labor productivity growth. We find that a decline in the contribution of international IST shocks, combined with weak domestic TFP growth, can explain the widely documented slowdown in UK labor productivity after the financial crisis. A standard two-country model implies widely-used restrictions on the relative price of investment which we find to be inconsistent with our empirical evidence that relies on a minimum of structure. We show that a two-sector version of this model with adjustment cost in investment and costly sectoral labor reallocation can capture the empirical dynamics

Fiscal policy shocks and international spillovers

The domestic and international transmission mechanism of fiscal policy shocks are analysed in large developed economies. Using a Bayesian VAR approach, we find that fiscal expansions are associated with increases in output, private consumption and, in many cases, with an in- crease in private investment. The terms of trade, which affect the international transmission of fiscal policy shocks, are found to depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansion- ary for most, but not all European economies, both within and outside the Euro Area. The dynamics of the BVAR are rationalised using a dynamics stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints

Commodity prices and labour market dynamics in small open economies

We show that a model of an advanced small open economy with exports in commodities and search and matching frictions in the labour market can match the impulse responses from a panel vector autoregression to an identified commodity price shock. Using a minimum distance strategy, we find that international financial risk sharing is low even for advanced small open economies. Moreover, a strong real exchange rate appreciation is key for an unexpected commodity price increase to induce a tightening of labour market conditions in the model that is in line with the empirical evidence. As in the case of technology shocks discussed by Shimer (2005), proper amplification of the commodity price shock requires a high value of the outside option for unemployed agents. However, vacancies and unemployment hardly respond whenever the real exchange rate channel is mute. These findings suggest the relevance of the open economy dimension for the transmission of demand-type shocks to the labour market more generally

fMRI Supports the Sensorimotor Theory of Motor Resonance

The neural mechanisms mediating the activation of the motor system during action observation, also known as motor resonance, are of major interest to the field of motor control. It has been proposed that motor resonance develops in infants through Hebbian plasticity of pathways connecting sensory and motor regions that fire simultaneously during imitation or self movement observation. A fundamental problem when testing this theory in adults is that most experimental paradigms involve actions that have been overpracticed throughout life. Here, we directly tested the sensorimotor theory of motor resonance by creating new visuomotor representations using abstract stimuli (motor symbols) and identifying the neural networks recruited through fMRI. We predicted that the network recruited during action observation and execution would overlap with that recruited during observation of new motor symbols. Our results indicate that a network consisting of premotor and posterior parietal cortex, the supplementary motor area, the inferior frontal gyrus and cerebellum was activated both by new motor symbols and by direct observation of the corresponding action. This tight spatial overlap underscores the importance of sensorimotor learning for motor resonance and further indicates that the physical characteristics of the perceived stimulus are irrelevant to the evoked response in the observer