Lumpy Investment, Sectoral Propagation, and Business Cycles
AbstractThis paper proposes a model of endogenous fluctuations in investment. A monopolistic producer has an incentive to invest when the aggregate demand is high. This causes a propagation of investment across sectors. When the investment follows an (S,s) policy, the propagation size can exhibit a significant fluctuation. We derive the probability distribution of the propagation size, and show that its variance can be large enough to match the observed investment fluctuations. We then implement this mechanism in a dynamic general equilibrium model to explore an investment-driven business cycle. By calibrating the model with the SIC 4-digit level industry data, we numerically show that the model replicates the basic structure of the business cycles. Recent empirical studies discover that the establishment level investment exhibits a lumpy behavior (cf. Doms and Dunne (RED 1998) and Cooper, Haltiwanger, and Power (AER 1999)). This behavior suggests that a firm follows an (S,s) policy due to a fixed cost of investments. This empirical finding has stimulated the macroeconomic investigation whether such an (S,s) investment at the firm level causes the aggregate fluctuations (cf. Caballero and Engel (Econometrica 1999) and Thomas (JPE 2002)). We consider the case when the investments of industries are strategically complement each other. Each good is produced by a monopolist, and all the goods are used as inputs to produce each good. If the strategic complementarity is too small, then the aggregate follows the law of large numbers even though the individual behavior is non-linear. If the strategic complementarity is too large, then the multiple equilibria emerge (cf. Shleifer (JPE 1986)). We show that the aggregate exhibits a modest fluctuation such as seen in the business cycles when the strategic complementarity is about the same magnitude of the micro-level fluctuations. The aggregate fluctuation is driven by the stochastic size of investment propagation across industries. Suppose that there are N industries. We obtain two analytical results. First, when the strategic complementarity is of order 1/N, we obtain the distribution function of the investment propagation size. The distribution follows a power-law distribution exponentially truncated in the tail. The variance of the aggregate fluctuation is much larger than its smoothly-adjusting counterpart. This contrasts with the "neutrality" theorem by Caplin and Spulber (QJE 1987) and Caballero and Engel (Econometrica 1991) which shows that the individual (S,s) behavior does not add up to the aggregate fluctuations due to the law of large numbers. Secondly, the aggregate variance does not depend on N when the strategic complementarity is exactly 1/N. This case corresponds to the constant returns to scale technology and the rigid wage and interest in the N-sector production model. This result shows the possibility of an endogeneous fluctuation of the aggregate production driven by the propagation of sectoral investments. Our scale-free aggregate fluctuation is caused by the feedback effect among individual non-linear behaviors. This mechanism can be seen as a generalization of the self-organized criticality proposed by Bak, Chen, Scheinkman, and Woodford (Ricerche Economiche 1993). The propagation process is dampened by the general equilibrium effect of flexible wage and interest or the decreasing returns to scale. We obtain the power-law distribution only when these dampening forces are nullified. The robustness of our fluctuation result in a general equilibrium setup has to be investigated by numerical simulations. We simulate a dynamic general equilibrium model which incorporates the investment propagation mechanism above. The magnitude and periodicity of the sectoral (S,s) behavior is calibrated by data on the SIC 4-digit U.S. manufacturing sectors. When the representative household's preference on consumption and leisure is sufficiently close to linear, we obtain the second moment properties of aggregate production, consumption, and investment that mimic those of the U.S. business cycles
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 774.
Date of creation: 2004
Date of revision:
Contact details of provider:
Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC
(S; s) policy; aggregation; propagation; heavy-tailed distribution;
Other versions of this item:
- Makoto Nirei, 2004. "Lumpy Investment, Sectoral Propagation, and Business Cycles," Computing in Economics and Finance 2004 330, Society for Computational Economics.
- E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Julia K. Thomas, .
"Is Lumpy Investment Relevant for the Business Cycle?,"
GSIA Working Papers
1998-E250, Carnegie Mellon University, Tepper School of Business.
- Julia K. Thomas, 2002. "Is Lumpy Investment Relevant for the Business Cycle?," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 508-534, June.
- Julia K. Thomas, 2002. "Is lumpy investment relevant for the business cycle?," Staff Report 302, Federal Reserve Bank of Minneapolis.
- Horvath, Michael, 2000. "Sectoral shocks and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 69-106, February.
- Xavier Gabaix, 2009.
"The Granular Origins of Aggregate Fluctuations,"
NBER Working Papers
15286, National Bureau of Economic Research, Inc.
- Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
- Vives, X., 1988.
"Nash Equilibrium With Strategic Complementarities,"
UFAE and IAE Working Papers
107-88, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
- Caplin, Andrew S & Spulber, Daniel F, 1987.
"Menu Costs and the Neutrality of Money,"
The Quarterly Journal of Economics,
MIT Press, vol. 102(4), pages 703-25, November.
- Dixit, Avinash K & Stiglitz, Joseph E, 1975.
"Monopolistic Competition and Optimum Product Diversity,"
The Warwick Economics Research Paper Series (TWERPS)
64, University of Warwick, Department of Economics.
- Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
- Caballero, R.J. & Engel, E.M.R.A., 1990.
"Dynamic (S,S) Economies,"
1990_44, Columbia University, Department of Economics.
- Selover David D. & Jensen Roderick V. & Kroll John, 2003. "Industrial Sector Mode-Locking and Business Cycle Formation," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 7(3), pages 1-39, October.
- Shleifer, Andrei, 1986.
3451303, Harvard University Department of Economics.
- Nirei, Makoto, 2006. "Threshold behavior and aggregate fluctuation," Journal of Economic Theory, Elsevier, vol. 127(1), pages 309-322, March.
- Mark Doms & Timothy Dunne, 1994.
"Capital Adjustment Patterns in Manufacturing Plants,"
94-11, Center for Economic Studies, U.S. Census Bureau.
- Mark E. Doms & Timothy Dunne, 1998. "Capital Adjustment Patterns in Manufacturing Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(2), pages 409-429, April.
- Yoshikawa, Hiroshi & Ohtake, Fumio, 1987. "Postwar business cycles in Japan: A quest for the right explanation," Journal of the Japanese and International Economies, Elsevier, vol. 1(4), pages 373-407, December.
- Dupor, Bill, 1999. "Aggregation and irrelevance in multi-sector models," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 391-409, April.
- Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
- Peter Bak & Kan Chen & Jose Scheinkman & Michael Woodford, 1992.
"Aggregate Fluctuations from Independent Sectoral Shocks: Self-Organized Criticality in a Model of Production and Inventory Dynamics,"
NBER Working Papers
4241, National Bureau of Economic Research, Inc.
- Bak, Per & Chen, Kan & Scheinkman, Jose & Woodford, Michael, 1993. "Aggregate fluctuations from independent sectoral shocks: self-organized criticality in a model of production and inventory dynamics," Ricerche Economiche, Elsevier, vol. 47(1), pages 3-30, March.
- Eric J. Bartelsman & Wayne Gray, 1996. "The NBER Manufacturing Productivity Database," NBER Technical Working Papers 0205, National Bureau of Economic Research, Inc.
- Lawrence J. Cristiano & Terry J. Fitzgerald, 1998. "The business cycle: it's still a puzzle," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q IV, pages 56-83.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann).
If references are entirely missing, you can add them using this form.