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

  • Julia K. Thomas
  • Aubhik Khan

We solve the first general equilibrium model of lumpy investment allowing a quantitative match with recent empirical evidence on establishment-level investment dynamics. In our model, establishments are subject to both persistent aggregate and persistent idiosyncratic shocks, and they face nonconvex adjustment costs and irreversibilities that lead them to pursue asymmetric generalized (S,s) investment policies. Previous partial equilibrium analysis suggests that this class of model embeds mechanisms that yield empirically relevant aggregate nonlinearities. While the aggregate implications of lumpy investment are very sensitive to general equilibrium, we find that the inclusion of idiosyncratic shocks yields plant-level investment dynamics that are essentially unaffected by movements in interest rates. If idiosyncratic shocks are a relatively significant source of uncertainty, this suggests there may be minimal loss in the common practice of analyzing investment dynamics under a fixed interest rate assumption, provided that attention is confined to microeconomic implications. However, we show that there is a tension in referencing large idiosyncratic uncertainty as the basis for partial equilibrium examinations of the consequences of lumpy investment. Specifically, even small idiosyncratic shocks sharply reduce the role of nonconvexities in explaining establishment-level investment. Related to this, we find that, even in disequilibrium, aggregate nonlinearities arise only when idiosyncratic shocks are small relative to aggregate shocks.

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 455.

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Date of creation: 2004
Date of revision:
Handle: RePEc:red:sed004:455
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Anil Kashyap & Francois Gourio, 2007. "Investment Spikes: New Facts and a General Equilibrium Exploration," 2007 Meeting Papers 148, Society for Economic Dynamics.
  2. 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.
  3. 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.
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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. Diego A. Comin & Thomas Philippon, 2006. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 167-228 National Bureau of Economic Research, Inc.
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  9. Russell Cooper & John Haltiwanger & Laura Power, 1995. "Machine Replacement and the Business Cycle: Lumps and Bumps," Papers 0062, Boston University - Industry Studies Programme.
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  11. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  12. Julia K. Thomas, . "Is Lumpy Investment Relevant for the Business Cycle?," GSIA Working Papers 1998-E250, Carnegie Mellon University, Tepper School of Business.
  13. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  14. 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.
  15. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  16. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
  17. Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: Market Power vs. Capital Market Imperfections," NBER Working Papers 8182, National Bureau of Economic Research, Inc.
  18. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," NBER Working Papers 7534, National Bureau of Economic Research, Inc.
  19. 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.
  20. 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.
  21. Khan, Aubhik & Thomas, Julia K., 2003. "Nonconvex factor adjustments in equilibrium business cycle models: do nonlinearities matter?," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 331-360, March.
  22. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  23. 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.
  24. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  25. Ruediger Bachmann & Eduardo Engel & Ricardo Caballero, 2006. "Lumpy Investment in Dynamic General Equilibrium," 2006 Meeting Papers 775, Society for Economic Dynamics.
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