Abstract
Once New Keynesian (NK) theory is combined with a standard model of lumpy investment, the resulting framework loses its ability to generate a realistic monetary transmission mechanism. This is the puzzle uncovered in Reiter, Sveen, and Weinke [Reiter, M., T. Sveen, and L. Weinke. 2013. “Lumpy Investment and the Monetary Transmission Mechanism.” Journal of Monetary Economics 60: 821–834.]. The simple economic reason behind it is the unrealistically large interest rate elasticity of investment, as implied by the standard theory of lumpy investment. In order to address this puzzle we develop a NK model featuring fully flexible investment combined with a financial friction. This model is used to isolate the quantitative importance of the financial friction for the monetary transmission mechanism.
Acknowledgement
Thanks to seminar participants at Freie Universität Berlin as well as to managing editor Tiago Cavalcanti and two anonymous referees. Janina Erichsen, Alina Imping and Rahel Mandaroux provided excellent research assistance. This research was funded by the Deutsche Forschungsgemeinschaft (DFG, German Research Foundation) – 402884221, and the Fonds zur Förderung der wissenschaftlichen Forschung (FWF Austrian Science Fund) – I3840-G27. Their financial support is gratefully acknowledged. The usual disclaimer applies.
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