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Fixed Costs and Long-Lived Investments

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  • Christopher House

    (University of Michigan and NBER)

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    Abstract

    Conventional 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 models with fixed costs differs importantly from the aggregate behavior of neoclassical models. The aggregate performance of models with fixed costs is important because most of our existing understanding of investment is based on models without fixed costs. Moreover, models with fixed costs of investment have non-degenerate, time-varying distributions of capital holdings across firms which make 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 the neoclassical model. The findings are not due to consumption smoothing motives but instead flow from the near infinite elasticity of investment timing for long-lived capital – a feature that the fixed-cost model shares with conventional neoclassical investment models. The analysis shows that the so-called “irrelevance results” obtained in recent numerical studies are not just parametric special cases but rather reflect deep fundamental properties of investment in long-lived capital.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 3.

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    Date of creation: 2008
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    Handle: RePEc:red:sed008:3

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    References

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    1. Mark Gertler & John Leahy, 2006. "A Phillips curve with an Ss foundation," Working Papers 06-8, Federal Reserve Bank of Philadelphia.
    2. Dmitriy Stolyarov, 2002. "Turnover of Used Durables in a Stationary Equilibrium: Are Older Goods Traded More?," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1390-1413, December.
    3. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," Harvard Institute of Economic Research Working Papers 1765, Harvard - Institute of Economic Research.
    4. Gourio, Francois & Kashyap, Anil K, 2007. "Investment spikes: New facts and a general equilibrium exploration," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 1-22, September.
    5. Christopher L. House & John V. Leahy, 2000. "An sS Model with Adverse Selection," NBER Working Papers 8030, National Bureau of Economic Research, Inc.
    6. Ruediger Bachmann & Ricardo J. Caballero & Eduardo Engel, 2006. "Lumpy Investment in Dynamic General Equilibrium," Cowles Foundation Discussion Papers 1566, Cowles Foundation for Research in Economics, Yale University.
    7. John Haltiwanger & Russell Cooper & 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.
    8. Aubhik Khan & Julia K. Thomas, . "Nonconvex Factor Adjustments in Equilibrium Business Cycle Models: Do Nonlinearities Matter?," GSIA Working Papers 2000-E33, Carnegie Mellon University, Tepper School of Business.
    9. Christopher L. House & Matthew D. Shapiro, 2008. "Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," American Economic Review, American Economic Association, vol. 98(3), pages 737-68, June.
    10. Marcelo Veracierto, 1998. "Plant level irreversible investment and equilibrium business cycles," Working Paper Series WP-98-1, Federal Reserve Bank of Chicago.
    11. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
    12. Christopher L. House & Emre Ozdenoren, 2006. "Durable Goods and Conformity," NBER Working Papers 12028, National Bureau of Economic Research, Inc.
    13. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
    14. Andrew C. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," NBER Working Papers 2311, National Bureau of Economic Research, Inc.
    15. Abel, Andrew B., 1982. "Dynamic effects of permanent and temporary tax policies in a q model of investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 353-373.
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    Cited by:
    1. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories and Real Rigidities in New Keynesian Business Cycle Models," Working Papers 09-9, Bank of Canada.
    2. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta-Eksten & Stephen J. Terry, 2012. "Really Uncertain Business Cycles," NBER Working Papers 18245, National Bureau of Economic Research, Inc.
    3. Oleksiy Kryvtsov & Virgiliu Midrigan, 2009. "Inventories, Markups, and Real Rigidities in Menu Cost Models," NBER Working Papers 14651, National Bureau of Economic Research, Inc.
    4. 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.
    5. Fabio Verona, 2011. "Lumpy investment in sticky information general equilibrium," CEF.UP Working Papers 1102, Universidade do Porto, Faculdade de Economia do Porto.
    6. Fiori, Giuseppe, 2012. "Lumpiness, capital adjustment costs and investment dynamics," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 381-392.
    7. Jianjun Miao & Pengfei Wang, . "Does Lumpy Investment Matter for Business Cycles?," Boston University - Department of Economics - Working Papers Series wp2010-002, Boston University - Department of Economics.
    8. Rüdiger Bachmann & Lin Ma, 2012. "Lumpy Investment, Lumpy Inventories," NBER Working Papers 17924, National Bureau of Economic Research, Inc.

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