The cyclical behavior of household and business investment in a cash-in-advance economy

This paper focuses on a monetary explanation of two business cycle regularities: (i) business and household investment are positively correlated and procyclical and (ii) business investment tends to lag household investment over the cycle. Our general equilibrium framework is essentially a standard cash-in-advance economy where households purchase both non-durable and durable consumption goods and businesses accumulate productive capital. Financial intermediaries provide interest bearing deposits to households and loanable funds to finance business investment. It is shown that the adaptation of particular interest rate rules by the monetary authority provides a mechanism to capture both the timing and direction of business and household investment. The results are then discussed within the context of recent limited participation models which emphasize the liquidity effects of monetary shocks. (C) 2003 Elsevier B.V. All rights reserved.