Zheng Liu, Pengfei Wang, and Tao Zha
Working Paper 2011-11
July 2011

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We argue that positive comovements between land prices and business investment are a driving force behind the broad impact of land-price dynamics on the macroeconomy. We develop an economic mechanism that captures the comovements by incorporating two key features into a DSGE model: we introduce land as a collateral asset in firms' credit constraints, and we identify a shock that drives most of the observed fluctuations in land prices. Our estimates imply that these two features combine to generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through the joint dynamics of land prices and business investment.

JEL classification: E21, E27, E32, E44

Key words: land prices, collateral assets, investment, dynamic multiplier, propagation mechanism, co-movements

For helpful discussions, the authors thank Susanto Basu, Larry Christiano, Russell Cooper, Morris Davis, Steve Durlauf, Marty Eichenbaum, John Fernald, Kris Gerardi, Mark Gertler, Simon Gilchrist, Mike Golosov, Pat Higgins, Matteo Iacoviello, Nobu Kiyotaki, Dirk Krueger, Junior Maih, Jim Nason, Lee Ohanian, Alberto Oritz-Bolanos, Richard Rogerson, Julio Rotemberg, Tom Sargent, Frank Schorfheide, Mark Spiegel, Harald Uhlig, Dan Waggoner, Carl Walsh, John Williams, and seminar participants at the Federal Reserve Banks of Atlanta and San Francisco, the 2009 NBER Summer Workshop on Impulse and Propagation Mechanisms, University of Pennsylvania, University of Wisconsin, Georgetown University, UCLA, UCSD, UC Riverside, UC Santa Cruz, UC Davis, USC, the European University Institute, the Banque de France, and the Bank of New Zealand's conference "Twenty Years of Inflation Targeting." They also thank David Lang, Jacob Smith, and Diego Vilán for research assistance and Anita Todd and Sam Zuckerman for editorial assistance. Pengfei Wang acknowledges the financial support from the Hong Kong Research Grant Council (project #643908). The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Zheng Liu, Federal Reserve Bank of San Francisco, 101 Market Street, MS 1130, San Francisco, CA 94105, zheng.liu@sf.frb.org; Pengfei Wang, Department of Economics, Hong Kong University of Science & Technology, Hong Kong, pfwang@ust.hk; or Tao Zha, Emory University, NBER, and Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8353, zha.cqer@gmail.com.

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