Firm-Specific Capital, Nominal Rigidities and the Business Cycle

This paper formulates and estimates a three-shock US business cycle model. The estimated model accounts for a substantial fraction of the cyclical variation in output and is consistent with the observed inertia in inflation. This is true even though firms in the model only reoptimize their prices on average once every 1.6 quarters. The key model feature underlying this result is that capital is firm-specific. If instead we adopt the standard assumption that capital is homogeneous and traded in economy-wide rental markets, we find that firms reoptimize their prices on average once every 6 quarters. We argue that the micro implications of the model strongly favors the firm-specific capital specification