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Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach

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  • Ricardo J. Caballero
  • Eduardo M. R. A. Engel

Abstract

In this paper, the authors derive a model of aggregate investment that builds from the lumpy microeconomic behavior of firms facing stochastic fixed adjustment costs. Instead of the standard sharp (S, s) bands, firms' adjustment policies take the form of a probability of adjustment (adjustment hazard) that responds smoothly to changes in firms' capacity gap. The model has appealing aggregation properties, and yields nonlinear aggregate time series processes. The passivity of normal times is, occasionally, more than offset by the brisk response to large accumulated shocks. Using within and out-of-sample criteria, the authors find that the model performs substantially better than the standard linear models of investment for postwar sectoral U.S. manufacturing equipment and structures investment data.

Suggested Citation

  • Ricardo J. Caballero & Eduardo M. R. A. Engel, 1999. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Econometrica, Econometric Society, vol. 67(4), pages 783-826, July.
  • Handle: RePEc:ecm:emetrp:v:67:y:1999:i:4:p:783-826
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    References listed on IDEAS

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    1. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296, National Bureau of Economic Research, Inc.
    2. Caballero, Ricardo J, 1993. "Durable Goods: An Explanation for Their Slow Adjustment," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 351-384, April.
    3. Alan S. Blinder, 1981. "Retail Inventory Behavior and Business Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 443-520.
    4. Guiseppe Bertola & Ricardo J. Caballero, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Oxford University Press, vol. 61(2), pages 223-246.
    5. Bernanke, Ben S, 1983. "The Determinants of Investment: Another Look," American Economic Review, American Economic Association, vol. 73(2), pages 71-75, May.
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    More about this item

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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