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

  • Ricardo J. Caballero
  • Eduardo M.R.A. Engel

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4887.

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Date of creation: Oct 1994
Date of revision:
Publication status: published as Econometrica, Vol. 67, no.4 (July 1999): 783-826.
Handle: RePEc:nbr:nberwo:4887
Note: EFG
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Giuseppe Bertola & Ricardo J. Caballero, 1991. "Irreversibility and Aggregate Investment," NBER Working Papers 3865, National Bureau of Economic Research, Inc.
  2. Bernanke, Ben S, 1983. "The Determinants of Investment: Another Look," American Economic Review, American Economic Association, vol. 73(2), pages 71-75, May.
  3. Alan S. Blinder, 1981. "Retail Inventory Behavior and Business Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 443-520.
  4. Caballero, Ricardo J, 1993. "Durable Goods: An Explanation for Their Slow Adjustment," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 351-84, April.
  5. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296 National Bureau of Economic Research, Inc.
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