Business Cycles, Investment Shocks, and the "Barro-King" Curse

Abstract

Recent empirical evidence identifies investment shocks as key driving forces behind business cycle fluctuations.However, existing New Keynesian models emphasizing these shocks counterfactually imply a negative unconditional correlation between consumption growth and investment growth, a weak positive unconditional correlation between consumption growth and output growth and anomalous profiles of cross-correlations involving consumption growth.These anomalies arise because of a short-run contractionary effect a positive investment shock on consumption.Such counterfactual co-movements are typical of the "Barro-King curse" (Barro and King 1984), wherein models with a real business cycle core must rely on technology shocks to account for the observed co-movement among output, consumption, investment, and hours.We show that two realistic additions to an otherwise standard medium scale New Keynesian model -namely, roundabout production and real per capita output growth stemming from trend growth in neutral and investment-specific technologies -can break the Barro-King curse and provide a more accurate account of unconditional business cycle comovements more generally.These two features substantially magnify the effects of neutral technology and investment shocks on aggregate fluctuations and generate a rise of consumption on impact of a positive investment shock.

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