TAILIEUCHUNG - Federal Reserve Bank of Minneapolis Research Department Staff Report 328: Business Cycle Accounting

Our empirical evidence is broadly consistent with the predictions of the entrenchment and information effects arguments. We find that earnings informativeness, measured by the earnings-return relation, is significantly negatively related to the ultimate owner’s control level, conditional on the owner having gained effective control. This evidence is consistent with the information effect. We also find that earnings informativeness is significantly negatively related to the degree of divergence between the ultimate owner’s control and the equity ownership level. This lends support to the entrenchment effect argument. The result is also consistent with the information effect argument, provided that controlling owners who want to protect proprietary information use stock pyramids or. | Federal Reserve Bank of Minneapolis Research Department Staff Report 328 Revised December 2006 Business Cycle Accounting V. V. Chari University of Minnesota and Federal Reserve Bank of Minneapolis Patrick J. Kehoe Federal Reserve Bank of Minneapolis and University of Minnesota Ellen R. McGrattan Federal Reserve Bank of Minneapolis and University of Minnesota ABSTRACT We propose a simple method to help researchers develop quantitative models of economic fluctuations. The method rests on the insight that many models are equivalent to a prototype growth model with time-varying wedges which resemble productivity labor and investment taxes and government consumption. Wedges corresponding to these variables efficiency labor investment and government consumption wedges are measured and then fed back into the model in order to assess the fraction of various fluctuations they account for. Applying this method to . data for the Great Depression and the 1982 recession reveals that the efficiency and labor wedges together account for essentially all of the fluctuations the investment wedge plays a decidedly tertiary role and the government consumption wedge none. Analyses of the entire postwar period and alternative model specifications support these results. Models with frictions manifested primarily as investment wedges are thus not promising for the study of business cycles. We thank the co-editor and three referees for useful comments. We also thank Kathy Rolfe for excellent editorial assistance and the National Science Foundation for financial support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. In building detailed quantitative models of economic fluctuations researchers face hard choices about where to introduce frictions into their models in order to allow the models to generate .

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