Abstract
Stock prices slowly adjust after the peak of a business cycle. High stock prices during the months following the peak result in a lower cost of capital for firms. Investment is much higher than it would be otherwise. We estimate a dynamic macroeconomic model in four variables: investment, stock prices, GDP, and interest rates. Stock prices are shown to be exogenous to the system, and investment is positively related to the stock prices. Investment and GDP would be significantly lower during the recessions since 1969 if stock prices adjusted immediately. High stock prices cushion the blow of the recession.
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