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Economic Instability and Aggregate Investment

In: NBER Macroeconomics Annual 1993, Volume 8

  • Robert S. Pindyck
  • Andrés Solimano

Recent literature suggests that because investment expenditures are irreversible and can be delayed, they may be highly sensitive to uncertainty. The authors briefly summarize the theory, stressing its empirical implications. Then, using cross-section and time-series data for a set of developing and industrial countries, they explore the empirical relevance of irreversibility and uncertainty to aggregate investment. They find that: (a) the volatility of the marginal profitability of capital (a summary measure of uncertainty) affects investment as the theory suggests, but the effect is moderate, and greatest for developing countries; (b)this volatility has little correlation with indices of political instability used in recent studies of growth; (c) inflation is highly correlated with this volatility and is a robust determinant of investment and the marginal profitability ofcapital. The volatility of the real exchange rate also has an independent contribution in explaining investment; and (d) the relationship between inflation and investment is nonlinear, and different thresholds of inflation, where the relationship with investment becomes stronger, were detected for a group of high-inflation countries in Latin America and low-inflation economies in the Organization for Economic Cooperation and Development (OECD).

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This chapter was published in:
  • Olivier Jean Blanchard & Stanley Fischer, 1993. "NBER Macroeconomics Annual 1993, Volume 8," NBER Books, National Bureau of Economic Research, Inc, number blan93-1, September.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11002.
    Handle: RePEc:nbr:nberch:11002
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