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Fixed Costs and Long-Lived Investments

Author

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  • Christopher House

    (University of Michigan and NBER)

Abstract

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.

Suggested Citation

  • Christopher House, 2008. "Fixed Costs and Long-Lived Investments," 2008 Meeting Papers 3, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:3
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    References listed on IDEAS

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    Cited by:

    1. Kryvtsov, Oleksiy & Midrigan, Virgiliu, 2010. "Inventories and real rigidities in New Keynesian business cycle models," Journal of the Japanese and International Economies, Elsevier, vol. 24(2), pages 259-281, June.
    2. Xiaoji Lin & Jack Favilukis, 2011. "Micro Frictions, Asset Pricing, and Aggregate Implications," 2011 Meeting Papers 466, Society for Economic Dynamics.
    3. Oleksiy Kryvtsov & Virgiliu Midrigan, 2013. "Inventories, Markups, and Real Rigidities in Menu Cost Models," Review of Economic Studies, Oxford University Press, vol. 80(1), pages 249-276.
    4. Jianjun Miao & Pengfei Wang, "undated". "Does Lumpy Investment Matter for Business Cycles?," Boston University - Department of Economics - Working Papers Series wp2010-002, Boston University - Department of Economics.
    5. Michael K. Johnston, 2009. "Real and Nominal Frictions within the Firm: How Lumpy Investment Matters for Price Adjustment," Staff Working Papers 09-36, Bank of Canada.

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