Working Paper

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

Abstract: The authors study 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. They 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 the cross-sectional distribution of establishment investment rates. Examining the implications of lumpy investment for aggregate dynamics in this setting, the authors 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, the authors 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. Their analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face idiosyncratic productivity shocks consistent with existing estimates, they find that nonconvex costs do not cause lumpy investments, but act to eliminate them.

Keywords: Investments;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2007

Number: 07-24