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Fixed Costs and Long-Lived Investments

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  • Christopher L. House

Abstract

Neoclassical investment models predict that firms should make frequent, small adjustments to their capital stocks. Microeconomic evidence, however, shows just the opposite -- firms make infrequent, large adjustments to their capital stocks. In response, researchers have developed models with fixed costs of adjustment to explain the data. While these models generate the observed firm-level investment behavior, it is not clear that the aggregate behavior of these models differs importantly from the aggregate behavior of neoclassical models. This is important since most of our existing understanding of investment is based on models without fixed costs. Moreover, models with fixed costs have non-degenerate, time-varying distributions of capital holdings across firms, making the models extremely difficult to analyze. This paper shows that, for sufficiently long-lived capital, (1) the cross-sectional distribution of capital holdings has virtually no bearing on the equilibrium and (2) the aggregate behavior of the fixed-cost model is virtually identical to that of the neoclassical model. The findings are due to a near infinite elasticity of investment timing for long-lived capital goods -- a feature that fixed-cost models and neoclassical models share. The analysis shows that the so-called "irrelevance results" obtained in recent numerical studies of fixed-cost models are not parametric special cases but instead reflect fundamental properties of long-lived investments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14402.

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Date of creation: Oct 2008
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Handle: RePEc:nbr:nberwo:14402

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Cited by:
  1. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta-Eksten & Stephen Terry, 2013. "Really uncertain business cycles," LSE Research Online Documents on Economics 51526, London School of Economics and Political Science, LSE Library.
  2. Verona, Fabio, 2012. "Lumpy investment in sticky information general equilibrium," IMFS Working Paper Series 55, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
  3. Oleksiy Kryvtsov & Virgiliu Midrigan, 2011. "Inventories, Markups and Real Rigidities in Sticky Price Models of the Canadian Economy," Working Papers 11-9, Bank of Canada.
  4. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories, Markups, and Real Rigidities in Menu Cost Models," Working Papers 09-6, Bank of Canada.
  5. Miao, Jianjun & Wang, Pengfei, 2009. "Does Lumy Investment Matter for Business Cycles?," MPRA Paper 14977, University Library of Munich, Germany.
  6. Jack Favilukis & Xiaoji Lin, 2011. "Micro Frictions, Asset Pricing and Aggregate," FMG Discussion Papers dp673, Financial Markets Group.
  7. Xiaoji Lin & Jack Favilukis, 2011. "Micro Frictions, Asset Pricing, and Aggregate Implications," 2011 Meeting Papers 466, Society for Economic Dynamics.
  8. Ryan Michaels & Michael Elsby, 2012. "Fixed Adjustment Costs and Aggregate Fluctuations," 2012 Meeting Papers 679, Society for Economic Dynamics.
  9. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories and Real Rigidities in New Keynesian Business Cycle Models," Working Papers 09-9, Bank of Canada.
  10. Rüdiger Bachmann & Lin Ma, 2012. "Lumpy Investment, Lumpy Inventories," NBER Working Papers 17924, National Bureau of Economic Research, Inc.
  11. Michael K. Johnston, 2009. "Real and Nominal Frictions within the Firm: How Lumpy Investment Matters for Price Adjustment," Working Papers 09-36, Bank of Canada.

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