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Irreversibility and Aggregate Investment

Listed author(s):
  • Giuseppe Bertola
  • Ricardo J. Caballero

Investment is often irreversible, in that installed capital has little or no value unless used in production. In the presence of ongoing uncertainty, an individual firm's irreversible investment policy optimally alternates short bursts of positive gross investment to periods of inaction, when the installed capital stock is allowed to depreciate. The behavior of aggregate investment series is characterized by sluggish, continuous adjustment instead. We argue in this paper that aggregate dynamics should be interpreted in terms of unsynchronized irreversible investment decisions by heterogenous firms, rather than in terms of ad-hoc adjustment cost functions in a representative-agent framework. We propose a closed-form solution for a realistic model of sequential irreversible investment, characterize the aggregate implications of microeconomic irreversibility and idiosyncratic uncertainty, and interpret U.S. data in light of the theoretical results.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3865.

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Date of creation: Oct 1991
Publication status: published as Review of Economic Studies, vol 61, no 2, pp 223-246, April 1994
Handle: RePEc:nbr:nberwo:3865
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