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Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics

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  • Julia K. Thomas
  • Aubhik Khan

Abstract

We solve the first general equilibrium model of lumpy investment allowing a quantitative match with recent empirical evidence on establishment-level investment dynamics. In our model, establishments are subject to both persistent aggregate and persistent idiosyncratic shocks, and they face nonconvex adjustment costs and irreversibilities that lead them to pursue asymmetric generalized (S,s) investment policies. Previous partial equilibrium analysis suggests that this class of model embeds mechanisms that yield empirically relevant aggregate nonlinearities. While the aggregate implications of lumpy investment are very sensitive to general equilibrium, we find that the inclusion of idiosyncratic shocks yields plant-level investment dynamics that are essentially unaffected by movements in interest rates. If idiosyncratic shocks are a relatively significant source of uncertainty, this suggests there may be minimal loss in the common practice of analyzing investment dynamics under a fixed interest rate assumption, provided that attention is confined to microeconomic implications. However, we show that there is a tension in referencing large idiosyncratic uncertainty as the basis for partial equilibrium examinations of the consequences of lumpy investment. Specifically, even small idiosyncratic shocks sharply reduce the role of nonconvexities in explaining establishment-level investment. Related to this, we find that, even in disequilibrium, aggregate nonlinearities arise only when idiosyncratic shocks are small relative to aggregate shocks.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 455.

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Date of creation: 2004
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Handle: RePEc:red:sed004:455

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Keywords: (S; s) policies; lumpy investment; irreversibilities;

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References

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  1. Russell Cooper & Joao Ejarque, 2000. "Exhuming Q: Market Power vs. Capital Market Imperfections," Econometric Society World Congress 2000 Contributed Papers 0528, Econometric Society.
  2. Julia K. Thomas, . "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1998-E250, Carnegie Mellon University, Tepper School of Business.
  3. Khan, Aubhik & Thomas, Julia K., 2003. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(2), pages 331-360, March.
  4. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
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  8. Marcelo Veracierto, 1998. "Plant level irreversible investment and equilibrium business cycles," Working Paper Series, Federal Reserve Bank of Chicago WP-98-1, Federal Reserve Bank of Chicago.
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  13. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(5), pages 867-896, October.
  14. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
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