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

  • Aubhik Khan
  • Julia K. Thomas

The authors study a model of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity, and nonconvex adjustment costs lead them to pursue generalized (S,s) investment rules. They allow persistent heterogeneity in both capital and total factor productivity alongside low-level investments exempt from adjustment costs to develop the first model consistent with the cross-sectional distribution of establishment investment rates. Examining the implications of lumpy investment for aggregate dynamics in this setting, the authors find that they remain substantial when factor supply considerations are ignored, but are quantitatively irrelevant in general equilibrium. ; The substantial implications of general equilibrium extend beyond the dynamics of aggregate series. While the presence of idiosyncratic shocks makes the time-averaged distribution of plant-level investment rates largely invariant to market-clearing movements in real wages and interest rates, the authors show that the dynamics of plants' investments differ sharply in their presence. Thus, model-based estimations of capital adjustment costs involving panel data may be quite sensitive to the assumption about equilibrium. Their analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face idiosyncratic productivity shocks consistent with existing estimates, they find that nonconvex costs do not cause lumpy investments, but act to eliminate them.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 07-24.

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Date of creation: 2007
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Handle: RePEc:fip:fedpwp:07-24
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  1. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  2. Aubhik Khan & Julia K. Thomas, 2000. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Working Papers 00-10, Federal Reserve Bank of Philadelphia.
  3. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, 05.
  4. Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: Market Power vs. Capital Market Imperfections," NBER Working Papers 8182, National Bureau of Economic Research, Inc.
  5. King, Robert G. & Rebelo, Sergio T., 1999. "Resuscitating real business cycles," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007 Elsevier.
  6. 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.
  7. Diego Comin & Thomas Philippon, 2005. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Working Papers 11388, National Bureau of Economic Research, Inc.
  8. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  9. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  10. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  11. 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.
  12. 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.
  13. Julia K. Thomas, . "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers 1998-E250, Carnegie Mellon University, Tepper School of Business.
  14. 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.
  15. 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.
  16. Giuseppe Bertola & Ricardo J. Caballero, 1991. "Irreversibility and Aggregate Investment," NBER Working Papers 3865, National Bureau of Economic Research, Inc.
  17. Marcelo L. Veracierto, 2002. "Plant-Level Irreversible Investment and Equilibrium Business Cycles," American Economic Review, American Economic Association, vol. 92(1), pages 181-197, March.
  18. 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.
  19. 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.
  20. Diego Valderrama, 2002. "Statistical nonlinearities in the business cycle: a challenge for the canonical RBC model," Working Paper Series 2002-13, Federal Reserve Bank of San Francisco.
  21. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns," GSIA Working Papers 1997-45, Carnegie Mellon University, Tepper School of Business.
  22. Ruediger Bachmann & Eduardo Engel & Ricardo Caballero, 2006. "Lumpy Investment in Dynamic General Equilibrium," 2006 Meeting Papers 775, Society for Economic Dynamics.
  23. repec:cup:macdyn:v:1:y:1997:i:2:p:387-422 is not listed on IDEAS
  24. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  25. Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: market power capital market imperfections," Working Papers 611, Federal Reserve Bank of Minneapolis.
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