Firm-specific capital, nominal rigidities and the business cycle

This paper formulates and estimates a three-shock U.S. 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 re-optimize prices on average once every 1.8 quarters. The key feature of our model underlying this result is that capital is firm-specific. If we adopt the standard assumption that capital is homogeneous and traded in economy-wide rental markets, we find that firms re-optimize their prices on average once every 9 quarters. We argue that the micro implications of the model strongly favor the firm-specific capital specification.