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Economic instability and aggregate investment

  • Pindyck, Robert S.
  • Solimano, Andres

Recent literature suggests that because investment expenditures are irreversible and can be delayed, they may be highly sensitive to uncertainty. The authors briefly summarize the theory, stressing its empirical implications. Then, using cross-section and time-series data for a set of developing and industrial countries, they explore the empirical relevance of irreversibility and uncertainty to aggregate investment. They find that: (a) the volatility of the marginal profitability of capital (a summary measure of uncertainty) affects investment as the theory suggests, but the effect is moderate, and greatest for developing countries; (b)this volatility has little correlation with indices of political instability used in recent studies of growth; (c) inflation is highly correlated with this volatility and is a robust determinant of investment and the marginal profitability ofcapital. The volatility of the real exchange rate also has an independent contribution in explaining investment; and (d) the relationship between inflation and investment is nonlinear, and different thresholds of inflation, where the relationship with investment becomes stronger, were detected for a group of high-inflation countries in Latin America and low-inflation economies in the Organization for Economic Cooperation and Development (OECD).

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1148.

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Date of creation: 30 Jun 1993
Date of revision:
Handle: RePEc:wbk:wbrwps:1148
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  1. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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  8. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
  9. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-77, March.
  10. Solimano, Andres, 1992. "Understanding the investment cycle in adjustment programs : evidence from reforming economies," Policy Research Working Paper Series 912, The World Bank.
  11. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
  12. Kormendi, Roger C. & Meguire, Philip G., 1985. "Macroeconomic determinants of growth: Cross-country evidence," Journal of Monetary Economics, Elsevier, vol. 16(2), pages 141-163, September.
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  15. Caballero, Ricardo J & Pindyck, Robert S, 1996. "Uncertainty, Investment, and Industry Evolution," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 641-62, August.
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  20. Pfeffermann, G.P. & Madarassy, A., 1992. "Trend in Private Investment in Developing Countries," Papers 14, World Bank - International Finance Corporation.
  21. Ricardo J. Caballero, 1991. "A Fallacy of Composition," NBER Working Papers 3735, National Bureau of Economic Research, Inc.
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  29. repec:oup:qjecon:v:98:y:1983:i:1:p:85-106 is not listed on IDEAS
  30. Pindyck, Robert, 1989. "Irreversibility, uncertainty, and investment," Policy Research Working Paper Series 294, The World Bank.
  31. Corbo, Vittorio & Solimano, Andres, 1991. "Chile's experience with stabilization, revisited," Policy Research Working Paper Series 579, The World Bank.
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  42. Serven, Luis & Solimano, Andres, 1993. "Debt crisis, adjustment policies and capital formation in developing countries: Where do we stand?," World Development, Elsevier, vol. 21(1), pages 127-140, January.
  43. Leahy, J.V., 1991. "The Optimality of Myopic Behaviour in a Competitive Model of Entry and Exit," Harvard Institute of Economic Research Working Papers 1566, Harvard - Institute of Economic Research.
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