Jianjun Miao, Pengfei Wang, and Tao Zha
Working Paper 2014-15
August 2014

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In the U.S. economy during the past 25 years, house prices exhibit fluctuations considerably larger than house rents, and these large fluctuations tend to move together with business cycles. We build a simple theoretical model to characterize these observations by showing the tight connection between price-rent fluctuation and the liquidity constraint faced by productive firms. After developing economic intuition for this result, we estimate a medium-scale dynamic general equilibrium model to assess the empirical importance of the role the price-rent fluctuation plays in the business cycle. According to our estimation, a shock that drives most of the price-rent fluctuation explains 30 percent of output fluctuation over a six-year horizon.

JEL classification: E22, E32, E44

Key words: asset pricing, financial frictions, working capital, cutoff productivity, heterogeneous firms, endogenous TFP, house price, liquidity constraint

The authors thank Larry Christiano, Marty Eichenbaum, Jordi Galí, Lars Hansen, Simon Gilchrist, Pat Higgins, Lee Ohanian, Monika Piazzesi, Sergio Rebelo, Richard Rogerson, Martin Schneider, and seminar participants at Vanderbilt University, Rochester University, the National Bureau of Economic Research Summer Institute 2014, and the 2014 Academy of Financial Research's Summer Institute of Economics and Finance for helpful discussions. This research is supported in part by National Science Foundation grant SES 1127665. 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 Jianjun Miao, Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215, 617-353-6675, miaoj@bu.edu; Pengfei Wang, Department of Economics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, 852 2358 7612, pfwang@ust.hk; or Tao Zha, Federal Reserve Bank of Atlanta and Emory University, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8353, zmail@tzha.net.

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