Explaining Investment Dynamics in U.S. Manufacturing: Generalized (S,s) Approach

In this paper we derive a model of aggregate investment that builds from the lumpy microeconomic behavior of firms facing stochastic fixed adjustment costs. Instead of the standard (S,s) bands, firms' optimal adjustment policies are probabilistic, with a probability of adjusting (adjustment hazard) that grows smoothly with firms' disequilibria. Depending upon the specification of the distribution of fixed adjustment costs, the adjustment hazards approach encompasses models ranging from the very non-linear (S,s) model to the linear partial adjustment model. Except for the latter extreme, the processes for aggregate investment obtained from adding up the actions of firms subject to aggregate and idiosyncratic shocks, is highly non-linear. Estimating the aggregate model by maximum likelihood, we find clear evidence supporting non-linear models over linear ones for postwar sectoral U.S. manufacturing equipment and structures investment. For a given sequence of aggregate shocks, the nonlinear model estimated generates brisker expansions and - to a lesser extent - sharper contractions than its linear counterpart. These features fit well the observed positive skewness and large kurtosis of U.S. manufacturing sectoral investment/capital ratios.(This abstract was borrowed from another version of this item.)