PRELIMINARY AND INCOMPLETE

Evidence from \u85rm-level data shows that capital separation and reallocation are impor-tant phenomena. Aggregate gross investment ows are thus substantially larger than the net ows reported in the national accounts. Furthermore, separation rates vary inversely with the cycle while reallocation rates are strongly procyclical. This suggests that capital stocks are more volatile and procyclical than in standard business cycle models. We build a search-and-matching model for capital with endogenous separation due to costly state veri\u85cation to capture these \u85rm-level characteristics about capital ows. We nd that compared to the frictionless counterpart but also compared to models of \u85nancial frictions without costly capital reallocation, our model generates substantial internal ampli-cation and matches surprisingly well the persistence in U.S. output growth. This suggests that credit market frictions in combination with costly capital allocation have important business cycle e¤ects