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Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics

Listed author(s):
  • Aubhik Khan
  • Julia K. Thomas

We solve equilibrium models of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity. Nonconvex adjustment costs lead plants to pursue generalized (S, s) rules with respect to capital; thus, their investments are lumpy. In partial equilibrium, this yields substantial skewness and kurtosis in aggregate investment, though, with differences in plant-level productivity, these nonlinearities are far less pronounced. Moreover, nonconvex costs, like quadratic adjustment costs, increase the persistence of aggregate investment, yielding a better match with the data. In general equilibrium, aggregate nonlinearities disappear, and investment rates are very persistent, regardless of adjustment costs. While the aggregate implications of lumpy investment change substantially in equilibrium, the inclusion of fixed costs or idiosyncratic shocks makes the average distribution of plant investment rates largely invariant to market-clearing movements in real wages and interest rates. Nonetheless, we find that understanding the dynamics of plant-level investment requires general equilibrium analysis.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 352.

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Date of creation: 2004
Handle: RePEc:fip:fedmsr:352
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  1. Francois Gourio & Anil K Kashyap, 2007. "Investment Spikes: New Facts and a General Equilibrium Exploration," NBER Working Papers 13157, National Bureau of Economic Research, Inc.
  2. 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.
  3. Julia K. Thomas, "undated". "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers 1998-E250, Carnegie Mellon University, Tepper School of Business.
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  5. Russell Cooper & Joao Ejarque, 2000. "Exhuming Q: Market Power vs. Capital Market Imperfections," Econometric Society World Congress 2000 Contributed Papers 0528, Econometric Society.
  6. Aubhik Khan & Julia K. Thomas, 2002. "Nonconvex factor adjustments in equilibrium business cycle models: Do nonlinearities matter?," Staff Report 306, Federal Reserve Bank of Minneapolis.
  7. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  8. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  9. Ruediger Bachmann & Eduardo Engel & Ricardo Caballero, 2006. "Lumpy Investment in Dynamic General Equilibrium," 2006 Meeting Papers 775, Society for Economic Dynamics.
  10. Marcelo Veracierto, 1998. "Plant level irreversible investment and equilibrium business cycles," Working Paper Series WP-98-1, Federal Reserve Bank of Chicago.
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  13. Chirinko, Robert S, 1993. "Business Fixed Investment Spending: Modeling Strategies, Empirical Results, and Policy Implications," Journal of Economic Literature, American Economic Association, vol. 31(4), pages 1875-1911, December.
  14. Guiseppe Bertola & Ricardo J. Caballero, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Oxford University Press, vol. 61(2), pages 223-246.
  15. Russell W. Cooper & Joao Ejarque, 2001. "Exhuming Q: market power capital market imperfections," Working Papers 611, Federal Reserve Bank of Minneapolis.
  16. Ruediger Bachmann & Ricardo J. Caballero & Eduardo Engel, 2008. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," Cowles Foundation Discussion Papers 1566R, Cowles Foundation for Research in Economics, Yale University, revised Apr 2010.
  17. Russell Cooper & John Haltiwanger & Laura Power, 1995. "Machine Replacement and the Business Cycle: Lumps and Bumps," NBER Working Papers 5260, National Bureau of Economic Research, Inc.
  18. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  19. Per Krusell & Anthony A. Smith, Jr., "undated". "Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns," GSIA Working Papers 1997-45, Carnegie Mellon University, Tepper School of Business.
  20. Richard Rogerson, 2010. "Indivisible Labor, Lotteries and Equilibrium," Levine's Working Paper Archive 250, David K. Levine.
  21. Robert S. Chirinko, 1993. "Business fixed investment spending: a critical survey of modeling strategies, empirical results, and policy implications," Research Working Paper 93-01, Federal Reserve Bank of Kansas City.
  22. Francois Gourio, 2007. "Disasters and Recoveries: A Note on the Barro-Rietz Explanation of the Equity Premium Puzzle," Boston University - Department of Economics - Working Papers Series WP2007-007, Boston University - Department of Economics.
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  24. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
  25. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862 Elsevier.
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