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Nonconvex factor adjustments in equilibrium business cycle models: Do nonlinearities matter?
Recent empirical analysis has found nonlinearities to be important in understanding aggregated investment. Using an equilibrium business cycle model, we search for aggregate nonlinearities arising from the introduction of nonconvex capital adjustment costs. We find that, while such costs lead to nontrivial nonlinearities in aggregate investment demand, equilibrium investment is effectively unchanged. Our finding, based on a model in which aggregate fluctuations arise through exogenous changes in total factor productivity, is robust to the introduction of shocks to the relative price of ...
Working Paper
Modeling inventories over the business cycle.
We search for useful models of aggregate fluctuations with inventories. We focus exclusively on dynamic stochastic general equilibrium models that endogenously give rise to inventory investment and evaluate two leading candidates: the (S,s) model and the stockout avoidance model. Each model is examined under both technology shocks and preference shocks, and its performance gauged by its ability to explain the observed magnitude of inventories in the U.S. economy, alongside other empirical regularities, such as the procyclicality of inventory investment and its positive correlation with sales. ...
Working Paper
The pitfalls of discretionary monetary policy.
In a canonical staggered pricing model, monetary discretion leads to multiple private sector equilibria. The basis for multiplicity is a form of policy complementarity. Specifically, prices set in the current period embed expectations about future policy, and actual future policy responds to these same prices. For a range of values of the fundamental state variable ? a ratio of predetermined prices ? there is complementarity between actual and expected policy, and multiple equilibria occur. Moreover, this multiplicity is not associated with reputational considerations: it occurs in a ...
Working Paper
Optimal monetary policy
Optimal monetary policy maximizes welfare, given frictions in the economic environment. Constructing a model with two sets of frictions - the Keynesian friction of costly price adjustment by imperfectly competitive firms and the Monetarist friction of costly exchange of wealth for goods - we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is ...
Working Paper
Inventories and the business cycle: an equilibrium analysis of (S,s) policies.
The authors develop an equilibrium business cycle model in which final goods producers pursue generalized (S,s) inventory policies with respect to intermediate goods, a consequence of nonconvex factor adjustment costs. Calibrating their model to reproduce the average inventory-to-sales ratio in postwar U.S. data, the authors find that it explains half of the cyclical variability of inventory investment. Moreover, inventory accumulation is strongly procyclical, and production is more volatile than sales, as in the data. The comovement between inventory investment and final sales is often ...
Working Paper
Enduring relationships in an economy with capital
Journal Article
The role of segmented markets in monetary policy
The popular press would lead us to believe that during the stock market boom of the 1990s just about everyone was buying and selling bonds every day. In fact, evidence shows that most households make only infrequent changes to their investment portfolios. "In The Role of Market Segmented Markets in Monetary Policy," Aubhik Khan discusses this market segmentation and its implication for the way monetary policy affects interest rates and inflation.
Journal Article
The finance and growth nexus
Does financial development lead to greater economic growth? Or does economic growth lead to more highly developed financial systems? In this article, Aubhik Khan presents some recent evidence that appears to support the first question: financial development may also have a significant impact on a nation's rate of economic growth.
Working Paper
Enduring Relationships in an Economy with Capital and Private Information
We study efficient risk sharing in a model where agents operate linear production technologies with private information about idiosyncratic productivity. Capital is the sole factor of production, and accumulable. We establish a time-invariant, one-to-one mapping between the capital allocated to an agent and his lifetime utility entitlement. The mapping implies properties that are distinct from those in models with private information about endowments. In contrast to the latter, the value of the risk-sharing arrangement in our model always remains above the autarky value. There is no need for ...
Working Paper
Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics
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 ...