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Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics

  • Aubhik Khan
  • Julia K. Thomas

    ()

    (Department of Economics University of Minnesota)

We examine a model of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity, and nonconvex adjustment costs lead them to pursue generalized (S,s) investment rules. We allow persistent heterogeneity in both capital and total factor productivity alongside low-level investments exempt from adjustment costs to develop the first model consistent with available evidence on establishment-level investment rates. Reassessing the implications of lumpy investment for aggregate dynamics in this setting, we find that they remain substantial when factor supply considerations are ignored, but are quantitatively irrelevant in general equilibrium. The substantial implications of general equilibrium extend beyond the dynamics of aggregate series. While the presence of idiosyncratic shocks makes the time-averaged distribution of plant-level investment rates largely invariant to market-clearing movements in real wages and interest rates, we show that the dynamics of plants' investments differ sharply in their presence. Thus, model-based estimations of capital adjustment costs involving panel data may be quite sensitive to the assumption about equilibrium. Our analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face large and weakly persistent idiosyncratic productivity shocks consistent with existing estimates, we find that nonconvex costs do not cause lumpy investments, but act to eliminate them

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 294.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:294
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