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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. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," NBER Working Papers 7534, National Bureau of Economic Research, Inc.
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  6. Marcelo Veracierto, 1997. "Plant level irreversible investment and equilibrium business cycles," Discussion Paper / Institute for Empirical Macroeconomics 115, Federal Reserve Bank of Minneapolis.
  7. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1996. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Documentos de Trabajo 12, Centro de Economía Aplicada, Universidad de Chile.
  8. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Aubhik Khan & Julia Thomas, 2002. "Nonconvex factor adjustments in equilibrium business cycle models: Do nonlinearities matter?," Staff Report 306, Federal Reserve Bank of Minneapolis.
  10. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
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  12. Ruediger Bachmann & Ricardo J. Caballero & Eduardo M.R.A. Engel, 2006. "Aggregate Implications of Lumpy Investment: New Evidence and a DSGE Model," NBER Working Papers 12336, National Bureau of Economic Research, Inc.
  13. Krusell, Per & Smith, Anthony A., 1997. "Income And Wealth Heterogeneity, Portfolio Choice, And Equilibrium Asset Returns," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 387-422, June.
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  18. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  19. Russell Cooper & Joao Ejarque, 2000. "Exhuming Q: Market Power vs. Capital Market Imperfections," Econometric Society World Congress 2000 Contributed Papers 0528, Econometric Society.
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  25. repec:cup:macdyn:v:1:y:1997:i:2:p:387-422 is not listed on IDEAS
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