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Federal Reserve Bank of San Francisco
Working Paper Series
Investment, capacity, and uncertainty: a putty-clay approach
Simon Gilchrist
John C. Williams

In this paper, we embed the microeconomic decisions associated with investment under uncertainty, capacity utilization, and machine replacement in a general equilibrium model based on putty-clay technology. We show that the combination of log-normally distributed idiosyncratic productivity uncertainty and Leontief utilization choice yields an aggregate production function that is easily characterized in terms of hazard rates for the standard normal distribution. At low levels of idiosyncratic uncertainty, the short-run elasticity of supply is substantially lower than the elasticity of supply obtained from a fully-flexible Cobb-Douglas alternative. In the presence of irreversible factor proportions, an increase in idiosyncratic uncertainty about the productivity of an investment project typically reduces investment at the micro level, but it raises aggregate investment. Increases in uncertainty also have important dynamic implications, causing sustained increases in investment and hours and a medium-term expansion in the growth rate of labor productivity.

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Simon Gilchrist & John C. Williams, Investment, capacity, and uncertainty: a putty-clay approach, Federal Reserve Bank of San Francisco, Working Paper Series 2002-03, 2002.
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Keywords: Productivity ; Industrial capacity
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