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Is Lumpy Investment Relevant for the Business Cycle?

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Author Info
Julia K. Thomas

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Abstract

The lumpiness of investment activity at the plant level is a well-established fact. Previous research has suggested that such discrete and occasional adjustments have significant aggregate implications. In particular, it has been argued that changes in plants' willingness to invest in response to aggregate shocks can at times generate large movements in total investment demand. In this study, I reassess these predictions in a general equilibrium environment. Specifically, assuming nonconvex costs of capital adjustment, I derive generalized (S, s) adjustment rules yielding lumpy plant-level investment within an otherwise standard equilibrium business cycle model. In contrast to previous partial equilibrium analyses, model results reveal that the aggregate effects of lumpy investment are negligible. In general equilibrium, households' preference for relatively smooth consumption profiles offsets changes in aggregate investment demand implied by the introduction of lumpy plant-level investment. As a result, adjustments in wages and interest rates yield quantity dynamics that are virtually indistinguishable from the standard model, and lumpy investment appears largely irrelevant for equilibrium business cycle analysis.

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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 110 (2002)
Issue (Month): 3 (June)
Pages: 508-534
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Handle: RePEc:ucp:jpolec:v:110:y:2002:i:3:p:508-534

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  1. Quantitative Macroeconomics and Real Business Cycles (QM&RBC)
References listed on IDEAS
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  1. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22. [Downloadable!]
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  2. James H. Stock & Mark W. Watson, 1998. "Business Cycle Fluctuations in U.S. Macroeconomic Time Series," NBER Working Papers 6528, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Blackwell Publishing, vol. 61(2), pages 223-46, April. [Downloadable!] (restricted)
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  4. Kevin A. Hassett & R. Glenn Hubbard, 1998. "Tax Policy and Investment," NBER Working Papers 5683, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," NBER Working Papers 5508, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Caballero, Ricardo J & Engel, Eduardo M R A, 1991. "Dynamic (S, s) Economies," Econometrica, Econometric Society, vol. 59(6), pages 1659-86, November. [Downloadable!] (restricted)
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  7. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  8. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November. [Downloadable!] (restricted)
  9. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1996. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Documentos de Trabajo 12, Centro de Economía Aplicada, Universidad de Chile.
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  10. Jonas D.M. Fisher & Andreas Hornstein, 1997. "(S,s) Inventory policies in general equilibrium," Working Paper 97-07, Federal Reserve Bank of Richmond. [Downloadable!]
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  11. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May. [Downloadable!] (restricted)
  12. Nobuhiro Kiyotaki & Kenneth D. West, 1997. "Business Fixed Investment and the Recent Business Cycle in Japan," NBER Working Papers 5546, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Caplin, A. & Leahy, J., 1992. "Aggregation and Optimization with State-Dependent Pricing," Harvard Institute of Economic Research Working Papers 1595, Harvard - Institute of Economic Research.
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  14. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January. [Downloadable!] (restricted)
  16. Russell Cooper & John Haltiwanger & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September. [Downloadable!] (restricted)
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  17. Marcelo L. Veracierto, 2002. "Plant-Level Irreversible Investment and Equilibrium Business Cycles," American Economic Review, American Economic Association, vol. 92(1), pages 181-197, March. [Downloadable!] (restricted)
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  18. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier. [Downloadable!] (restricted)
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  19. Abel, Andrew B & Eberly, Janice C, 1996. "Optimal Investment with Costly Reversibility," Review of Economic Studies, Blackwell Publishing, vol. 63(4), pages 581-93, October. [Downloadable!] (restricted)
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  20. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232. [Downloadable!] (restricted)
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