Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment

33 Pages Posted: 6 May 2005

See all articles by Philippe Aghion

Philippe Aghion

College de France and London School of Economics and Political Science, Fellow; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Abhijit V. Banerjee

Massachusetts Institute of Technology (MIT) - Department of Economics

George-Marios Angeletos

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Kalina Manova

University College London - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 30, 2005

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.

Keywords: Growth, fluctuations, business cycle, credit constraints, amplification, R&D

JEL Classification: E22, E32, O16, O30, O41, O57

Suggested Citation

Aghion, Philippe and Banerjee, Abhijit V. and Angeletos, George-Marios and Manova, Kalina B., Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment (April 30, 2005). MIT Department of Economics Working Paper No. 05-15. Available at SSRN: https://ssrn.com/abstract=719772 or http://dx.doi.org/10.2139/ssrn.719772

Philippe Aghion

College de France and London School of Economics and Political Science, Fellow ( email )

London
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Abhijit V. Banerjee

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Room E52-252D
Cambridge, MA 02142
United States
617-253-8855 (Phone)
617-253-6915 (Fax)

George-Marios Angeletos (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Room E52-251b
Cambridge, MA 02142
United States
617-452-3859 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kalina B. Manova

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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