Investment Hangover and the Great Recession
- American Economic Journal: Macroeconomics (Forthcoming)
We present a model of investment hangover motivated by the Great Recession.
Overbuilding of durable capital such as housing requires a reallocation
of productive resources to other sectors, which is facilitated
by a reduction in the interest rate. When monetary policy is constrained,
overbuilding induces a demand-driven recession with limited reallocation
and low output. Investment in other capital initially declines due to
low demand, but it later booms and induces an asymmetric recovery in
which the overbuilt sector is left behind. Welfare can be improved by ex post
policies that stimulate investment (including in overbuilt capital),
and ex ante policies that restrict investment.
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