SSE/EFI Working Paper Series in Economics and Finance
Vintage Capital and Expectations Driven Business Cycles
Abstract: This paper demonstrates that increased optimism about
future productivity can generate an immediate economic expansion in a
neoclassical model with vintage capital and variable capacity utilization.
Previous research has documented that standard neoclassical models cannot
generate a simultaneous increase in consumption, investment, and hours in
response to news shocks, and that optimism in these models tends to reduce
investment and hours. When technology is vintage specific, however,
expectations of higher future productivity raise the demand for new
vintages of capital relative to old capital. Capital depreciates faster
when utilization is high, but this depreciation only affects installed
capital. The cost of high depreciation therefore falls when the value of
installed capital falls. It is demonstrated here that with standard
parameter values, more optimism raises utilization, consumption,
investment, hours, and output.
Keywords: Expectations; News; Business cycles; Vintage capital; Capital-embodied technological change; (follow links to similar papers)
JEL-Codes: E13; E32; (follow links to similar papers)
22 pages, November 10, 2006
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