Abstract

This paper studies how business cycle dynamics are affected by the possibility to rent as opposed to own productive capital. We provide empirical evidence based on firm-level data for the US which confirms the counter-cyclicality of the share of renting in capital expenditure over the business cycle. We develop a dynamic stochastic general equilibrium model with borrowing constraints and two types of agents, and allow for both owned and rented capital to be used in production. The model focuses on a fundamental trade-off between the two types of capital: only owned capital can serve as collateral, but owning requires more liquidity than renting. The model performs well in replicating the counter-cyclical behavior of the rental share and matching some of the key business cycle moments observed in the data. Finally, simulation results show that the presence of a renting sector alleviates the adverse impacts of a negative financial shock, and these results are confirmed by empirical cross-country evidence.