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Fixed Costs and Long-Lived Investments

  • Christopher House

    (University of Michigan and NBER)

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    Conventional neoclassical investment models predict that firms should make frequent, small adjustments to their capital stocks. Microeconomic evidence however, shows just the opposite – firms make infrequent, large adjustments to their capital stocks. In response, researchers have developed models with fixed costs of adjustment to explain the data. While these models generate the observed firm-level investment behavior, it is not clear that the aggregate behavior of models with fixed costs differs importantly from the aggregate behavior of neoclassical models. The aggregate performance of models with fixed costs is important because most of our existing understanding of investment is based on models without fixed costs. Moreover, models with fixed costs of investment have non-degenerate, time-varying distributions of capital holdings across firms which make the models extremely difficult to analyze. This paper shows that, for sufficiently long-lived capital, (1) the cross-sectional distribution of capital holdings has virtually no bearing on the equilibrium and (2) the aggregate behavior of the fixed-cost model is virtually identical to the neoclassical model. The findings are not due to consumption smoothing motives but instead flow from the near infinite elasticity of investment timing for long-lived capital – a feature that the fixed-cost model shares with conventional neoclassical investment models. The analysis shows that the so-called “irrelevance results” obtained in recent numerical studies are not just parametric special cases but rather reflect deep fundamental properties of investment in long-lived capital.

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    File URL: https://economicdynamics.org/meetpapers/2008/paper_3.pdf
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    Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 3.

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    Date of creation: 2008
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    Handle: RePEc:red:sed008:3
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    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

    Web page: http://www.EconomicDynamics.org/society.htm
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