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Identifying Aggregate Shocks with Micro-level Heterogeneity: Financial Shocks and Investment Fluctuation

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  • Xing Guo

Abstract

This paper identifies aggregate financial shocks and quantifies their effects on business investment based on an estimated DSGE model with firm-level heterogeneity. On average, financial shocks contribute only 3% of the variation in U.S. public firms’ aggregate investment. The negligible aggregate relevance of financial shocks mainly results from the interaction between firm-level heterogeneity and general equilibrium effects. Following a contractionary financial shock, financially constrained firms are directly forced to cut investment, which dampens the aggregate investment demand and lowers the price of capital good. A lower capital good price motivates the financially unconstrained firms to invest more, which largely cancels out the financial shock’s direct effect on aggregate. If I abstract from firm-level heterogeneity, the implied relevance of financial shocks to aggregate investment is 15 times larger. This sharp difference indicates that representative firm models could overstate the relevance of financial shocks in driving the business cycle fluctuations, and highlights the important role played by the interaction between of micro-level heterogeneity and general equilibrium effects in shaping the transmission of aggregate shocks.

Suggested Citation

  • Xing Guo, 2020. "Identifying Aggregate Shocks with Micro-level Heterogeneity: Financial Shocks and Investment Fluctuation," Staff Working Papers 20-17, Bank of Canada.
    • Handle: RePEc:bca:bocawp:20-17
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    Cited by:

    1. Cooper Howes, 2019. "Financial Constraints, Sectoral Heterogeneity, and the Cyclicality of Investment," 2019 Meeting Papers 1581, Society for Economic Dynamics.
    2. Felipe Alves & Christian Bustamante & Xing Guo & Katya Kartashova & Soyoung Lee & Thomas Michael Pugh & Kurt See & Yaz Terajima & Alexander Ueberfeldt, 2022. "Heterogeneity and Monetary Policy: A Thematic Review," Discussion Papers 2022-2, Bank of Canada.

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    More about this item

    Keywords

    Business fluctuation and cycles; Firm dynamics;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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