“Financial Frictions on Capital Allocation: The Engine of TFP Fluctuations” by Zheng SONG
University of Oslo
This paper provides a theory on financial frictions as the engine of aggregate TFP fluctuations. In our model, financial frictions affect aggregate productive efficiency via capital allocation across different production units. News shocks on future technology improvement are introduced as a device to identify TPF fluctuations originating from such frictions. We find that variations of financial frictions in response to news shocks can trigger sizable fluctuations in aggregate TFP before the actual technology improvement is realized. The TFP fluctuations originating from capital reallocation, furthermore, lead to business cycles by allowing positive comovement among current output, consumption, investment, and hours worked. Our empirical evidence using a combined dataset from Compustat and IBES supports the role of financial frictions on capital allocation as the engine of TFP fluctuations over the U.S. business cycles.