Large Open Economies and Fixed Costs of Capital Adjustment

Capital reallocation creates excess volatility in investment in many two-country open economy models. Convex adjustment costs to capital have become a standard tool to deal with this. However, current microeconomic investment models feature non-convex adjustment costs as the dominant friction. This paper analyzes fixed costs to capital adjustment in a two-country business cycle model and finds that fixed costs - unlike in closed economies - dampen aggregate investment volatilities. Moreover, convex adjustment costs can serve as a stand-in for these fixed adjustment costs when one is interested in aggregate dynamics only. Yet, the mapping between fixed and quadratic adjustment costs co-depends on other model parameters. (Copyright: Elsevier)