Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics

FRB Minneapolis Staff Report No. 352

FRB Philadelphia Working Paper No. 07-24

48 Pages Posted: 3 Oct 2004

See all articles by Aubhik Khan

Aubhik Khan

Ohio State University (OSU)

Julia K. Thomas

University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2004

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: (S,s), policies, establishment investment, nonlinearities, lumpy investment

JEL Classification: E22, E32

Suggested Citation

Khan, Aubhik and Thomas, Julia K., Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics (August 2004). FRB Minneapolis Staff Report No. 352, FRB Philadelphia Working Paper No. 07-24, Available at SSRN: https://ssrn.com/abstract=598224 or http://dx.doi.org/10.2139/ssrn.598224

Aubhik Khan (Contact Author)

Ohio State University (OSU) ( email )

2120 Fyffe Road
Columbus, OH OH 43210
United States

Julia K. Thomas

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
612-626-9675 (Phone)
612-624-0209 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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