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

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Listed:
  • Julia K. Thomas
  • Aubhik Khan

Abstract

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.

Suggested Citation

  • Julia K. Thomas & Aubhik Khan, 2004. "Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics," 2004 Meeting Papers 455, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:455
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    References listed on IDEAS

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    More about this item

    Keywords

    (S; s) policies; lumpy investment; irreversibilities;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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