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Shocks to the marginal efficiency of investment are the most important drivers of business cycle fluctuations in U.S. output and hours. Moreover, these disturbances drive prices higher in expansions, like a textbook demand shock.

Investment Shocks and Business Cycles
Last Updated: 07/16/08

Shocks to the marginal efficiency of investment are the most important drivers of business cycle fluctuations in U.S. output and hours. Moreover, these disturbances drive prices higher in expansions, like a textbook demand shock. The authors reach these conclusions by estimating a DSGE model with several shocks and frictions. They also find that neutral technology shocks are not negligible, but their share in the variance of output is only around 25 percent, and even lower for hours. Labor supply shocks explain a large fraction of the variation of hours at very low frequencies, but not over the business cycle. Finally, they show that imperfect competition and, to a lesser extent, technological frictions are the key to the transmission of investment shocks in the model.