No full-text available
To read the full-text of this research,
you can request a copy directly from the author.
Plant level irreversible investment and equilibrium business cycles
Abstract
We present an analytically tractable general equilibrium business cycle model that features micro-level investment lumpiness. We prove an exact irrelevance proposition which provides sufficient conditions on preferences, technology, and the fixed cost distribution such that any positive upper support of the fixed cost distribution yields identical equilibrium dynamics of the aggregate quantities normalized by their deterministic steady state values. We also give two conditions for the fixed cost distribution, under which lumpy investment can be important to a first-order approximation: (i) The steady-state elasticity of the adjustment rate is large so that the extensive margin effect is large. (ii) More mass is on low fixed costs so that the general equilibrium price feedback effect is small.
... Despite the theoretical and methodological differences in these two approaches, we find some common patterns, namely that the output gap is equal to zero in the long run, despite transitory deviations, and consequently that permanently lower equilibrium rates of growth or output levels can only be explained through exogenous supply shocks, either stationary of non-stationary, affecting the level of capital rather than its degree of utilization. Consistently with this general framework, a growing stream of research has introduced some forms of non-linearity and discontinuity in capital stock adjustments at the micro-level in order to account for the empirically observed variability of aggregate investments during business cycles (Caballero & Pindyck, 1992;Bertola & Caballero, 1994;Abel & Eberly, 1999;Caballero & Engel, 1999;Veracierto, 2002;Thomas, 2002;Kahn & Thomas, 2008;Bachman et al, 2013). In particular, we can distinguish different approaches to discontinuity in investment decisions based on the (S,s) model. ...
... Caballero & Engel (1999), for instance, assume that desired capital evolves according to a random walk process, in line with the standard RBC literature. Non-convex adjustment costs, however, are not a necessary condition to have persistence; an accurate calibration of the model can generate persistent fluctuations even by assuming linear investment functions in otherwise standard RBC models (Veracierto, 2002;Thomas, 2002;Kahn & Thomas, 2008;Miao & Wang, 2014). Moreover, non-convex adjustment costs are not even a sufficient condition to have hysteresis: by assuming that desired capital follows a stationary and ergodic process, current capital would be stationary and ergodic as well, although exhibiting a small persistence depending on the weight of fixed costs relatively to capital stock depreciation. ...
... Since the seminal paper by Dixit (1989), the existence of sunk costs and the consequent non linearity in investment decisions has become a non negligible issue. A stream of research (Bertola & Caballero, 1994;Abel & Eberly, 1999;Bloom, 2000;Veracierto, 2002;Kahn & Thomas, 2008) has focused on the explanatory power of non-linear investment functions to account for aggregate investment variability, while a second stream of research (Cross et al, 1993;Amable et al, 1993Amable et al, , 1995Piscitelli et al, 1999Piscitelli et al, , 2000Serafini, 2001;De Peretti & Lang, 2009) has focused on the theoretical relevance of non-linearity to account for equilibrium endogeneity and, more specifically, hysteresis. While the first stream of research has mainly developed along with partial and/or general equilibrium models and concluded on the long run neutrality of micro non-linearity, the second stream of research has focused on the long run properties of non-linear investment functions in the framework of the original model of hysteresis (Preisach, 1935) without, however, integrating such a framework in larger macroeconomic models. ...
The neoclassical theory developed historically around the concept of (partial or general) equilibrium, by assuming its long run stability and independence from monetary and real fluctuations. The growing emphasis on path-dependence and, particularly, on the concept of hysteresis calls into question the traditional method, by rejecting the theoretical validity of the neoclassical equilibrium and its related stability properties. This thesis focuses on the model of “genuine” hysteresis, which first developed in the field of physics and recently extended its application to economic phenomena. Far from suggesting an appropriation of the methods that are typical of “hard” sciences, the aim is to analyze the consequences of discontinuous and hysteretic investment decisions on business cycles and long run trajectories. By relying on the Post Keynesian theory of growth and distribution, and the multi-agent methodological approach, this thesis develops a macroeconomic theoretical model that is able to generate non-linear business cycles around transitory equilibria, which are fully endogenous and historically determined according to the specific adjustment path. This theoretical framework confirms and reinforces the traditional Post Keynesian implications of income inequalities on the degree of utilization of productive capacity and on long run growth. Moreover, expansionary demand policies regain a central role in driving the economy towards the full employment of productive resources.
... 2 Despite its intuitive appeal, the effect of uncertainty on investment in the presence of irreversibilities can be theoretically ambiguous. As shown, for example, by Abel (1983), Veracierto (2002), and Bachmann and Bayer (2009), the effect depends importantly on the assumptions regarding the initial accumulation of capital, market structure, and the equilibrium setting. 3 Cooley and Quadrini (2001), Hennessy and Whited (2007), and Philippon (2009) consider similar contracting frameworks, though only in partial equilibrium. ...
... To keep the model tractable, we do not explicitly model the firms' endogenous entry/exit decisions. Rather, as in Cooley and Quadrini (2001) and Veracierto (2002), we assume that a constant fraction (1 − η) of firms in the economy exogenously exits in each period and is replaced by new entrants within the same period. An additional benefit of this stochastic overlapping generation structure is that it provides a convenient way to motivate the use of leverage by firms in the steady state, thereby obviating the need to introduce a corporate income tax shield in the model. ...
... As shown by Veracierto (2002) and Sim (2006), the irreversibility constraint alone does not fundamentally modify the dynamics of equilibrium business cycle when the driving force of the business fluctuation is the technology shock. 34 The addition of financial market frictions also does not appear to significantly alter the the dynamic response of the economy. ...
We appreciate comments and suggestions from Nobuhiro Kiyotaki, Neng Wang and the seminar participants at the Federal Reserve Board, the Federal Reserve Banks of Dallas and Chicago, the 2009 LAEF Conference at the UC– Santa Barbara, the 2009 Macro System Conference at the Federal Reserve Bank of San Francisco, the 2010 Winter Meetings of the Econometric Society, Princeton University, the 2010 Meeting of the Society for Economic Dynamics, and the 2010 NBER Summer Institute. Robert Kurtzman and Oren Ziv provided outstanding research assistance. All errors and omissions are our own responsibility alone. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System.
... In reality, the constraint is unlikely to bind even at the sectoral level. Therefore despite many valuable insights, the ability of this literature to explore the consequences of micro-level irreversibility is limited.Veracierto(2002)is an important exception. ...
... Despite a number of useful insights regarding the macroeconomic consequences of the constraint, the analysis of Veracierto(2002) assumes certainty equivalence and therefore is not able to analyze how the general equilibrium mechanism modifies the properties of the value of waiting established in the partial equilibrium literature. Because the analysis of the interplay between the investment option value and general equilibrium is absent inVeracierto(2002), he reaches an essentially identical conclusion toBertola and Caballero(1994)despite his general equilibrium setting: (i) the target capital of active firms responds to exogenous shocks in the same way as in the case of no adjustment friction, ...
... Second, in section 5.4, we consider time varying uncertainty in order to investigate how the short run changes in uncertainty affect aggregate investment dynamics under the irreversibility constraint at a general equilibrium level. There are many studies that emphasize that it is the changes in uncertainty, rather than the long run level of uncertainty, that matter for the value of waiting and therefore theWe now briefly explain the calibration of the second class of parameters as more detailed explanation can be found inVeracierto(2002). The one period utility function for households is specified as ...
This paper studies the long and short run macroeconomic consequences of irreversible invest-ment at the micro level. It is well known that the irreversibility constraint has two opposing effects on long run capital accumulation. On one hand, the constraint leads to increased capital accumulation, as firms are prevented from selling installed capital (the hangover effect). On the other hand, the constraint decreases capital accumulation by creating a strictly positive value of waiting for the installation of new capital (the user cost effect). In contrast to earlier studies, we find that in general equilibrium, the user cost effect dominates the hangover effect over a wide range of parameter values. Furthermore, increases in uncertainty monotonically decrease the level of capital accumulation relative to that of the flexible case. As for short run dynamics, previ-ous findings in the literature are reversed: we find that irreversibility does not create smoother aggregate investment dynamics relative to the flexible benchmark case. In general equilibrium, the economy-wide desire for consumption smoothing substantially destroys the value of waiting. Because the capital stock of inactive firms (those with binding constraints) cannot be used for consumption smoothing, the investment policy of active firms is more responsive to exogenous shocks. We show that the investment response of active firms can be strong enough to compen-sate for the inaction of firms with overcapacity and that this finding is robust with respect to the level of uncertainty. Irreversibility also leads to an increase in the volatility of firms' stock market values, due to the absence of the stabilizing role of the disinvestment option. Finally, we consider the role that short run time-varying uncertainty plays in equilibrium business cycles under the irreversibility constraint. We conclude that an increase in short run uncertainty can exert a more harmful impact on capital formation than an equivalent increase in long run uncertainty.
... 2 Despite its intuitive appeal, the effect of uncertainty on investment in the presence of irreversibilities can be theoretically ambiguous. As shown, for example, by Abel (1983) and Veracierto (2002), the effect depends importantly on the assumptions regarding the initial accumulation of capital, market structure, and the equilibrium setting. erogeneous firms employ a decreasing returns-to-scale production technology that is subject to a persistent idiosyncratic shock, the variance of which is allowed to vary over time according to a stochastic law of motion. ...
... To keep the model tractable, however, we do not explicitly model the firm's endogenous entry/exit decision. As in Cooley and Quadrini (2001) and Veracierto (2002), we assume that a constant fraction 1 − η of firms exogenously exits the industry in each period and that the exiting firms are replaced by identical new firms within the same period. ...
Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional "wait-and-see" effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions. The model successfully replicates the stylized facts concerning the macroeconomic implications of uncertainty and financial shocks. By influencing the effective supply of credit, both types of shocks exert a powerful effect on investment and generate countercyclical credit spreads and procyclical leverage, dynamics consistent with the data and counter to those implied by the technology-driven real business cycle models.
... We present our method in continuous time. While discrete time poses no conceptual difficulty (in fact, Campbell [1998], Dotsey, King, and Wolman [1999], Veracierto [2002], and Reiter [2009] originally proposed this general approach in discrete time), working in continuous time has three key numerical advantages that we heavily exploit. ...
... As we discuss in more detail below, the use of linearization to solve heterogeneous agent economies is not new. Our method builds on the ideas of Dotsey et al. (1999), Campbell (1998), Veracierto (2002), and Reiter (2009), and is related to Preston and Roca (2007). In contrast to these contributions, we cast our linearization method in continuous time. ...
We develop an efficient and easy to use computational method for solving a wide class of general equilibrium heterogeneous agent models with aggregate shocks together with an open source suite of codes that implement our algorithms in an easy to use toolbox. Our method extends standard linearization techniques and is designed to work in cases when inequality matters for the dynamics of macroeconomic aggregates. We present two applications that analyze a two asset incomplete markets model parameterized to match the distribution of income, wealth, and marginal propensities to consume. First, we show that our model is consistent with two key features of aggregate consumption dynamics that are difficult to match with representative agent models: (1) the sensitivity of aggregate consumption to predictable changes in aggregate income, and (2) the relative smoothness of aggregate consumption. Second, we extend the model to feature capital-skill complementarity and show how factor-specific productivity shocks shape dynamics of income and consumption inequality.
... The later (S,s) models focus on the implication of lumpy adjustment in general equilibrium. Veracierto [2002] integrated the generalized (S,s) model into a neoclassical growth framework where heterogeneous establishments are subject to partially irreversible investment and found that in the general equilibrium framework large effect of lumpiness disappears. This result is confirmed by Thomas [2002], Khan and Thomas [2003], who showed that in general equilibrium household preference for smoothing consumption predominates effects caused by lumpiness in the micro-level. ...
... Similar results have been also found in the capital adjustment context. See, e.g.,Veracierto [2002] andThomas [2002].4 To quantify the concept of lumpy labor adjustment,Caballero et al. [1997a] used a hazard function in terms of economic deviations from optimal targets. ...
In dieser Arbeit werden die Folgen der Calvo-Annahme in dynamischen makroökonomischen Modellen untersucht. Dafür wird die Calvo-Annahme unter Anwendung des Konzepts der statistischen Hazardfunktion verallgemeinert. Ich untersuche zwei mögliche Anwendungen dieses Ansatzes innerhalb von DSGE-Modellen. Im ersten Artikel zeige ich, dass der Zugewinn an Handhabbarkeit, der aus der Calvo-Annahme für Neu-Keynesianische Modelle folgt, mit unerwünschten Folgen in Bezug auf die Inflationsdynamiken einher geht. Der zweite Artikel schätzt die aggregierte Hazardfunktion unter Verwendung des theoretischen Rahmens des ersten Artikels. Es zeigt sich, dass die Annahme einer konstanten Hazardfunktion, die aus der Calvo-Annahme folgt, von den Daten eindeutig abgelehnt wird. Im dritten Artikel analysiere ich die Implikationen der empirisch geschätzten Hazardfunktion für die Persistenz von Inflation und die Geldpolitik. Die Untersuchungen zeigen, dass mittels der empirisch plausiblen aggregierten Hazardfunktion Zeitreihen simuliert werden können, die mit der Persistenz der inflatorischen Lücke im US Verbraucherpreisindex konsistent sind. Anhand dieser Ergebnisse komme ich zu dem Schluss, dass die Hazardfunktion eine entscheidende Rolle für die dynamischen Eigenschaften von Inflation spielt. Der letzte Artikel wendet den selben Modellierungsansatz auf ein Real-Business-Cycle Model mit rigidem Arbeitsmarkt an. Unter Verwendung eines allgemeineren stochastischen Anpassungsprozess stelle ich fest, dass die Arbeitsmarktdynamiken von einem Parameter beinflusst werden, der das Monotonieverhalten der Hazardfunktion bestimmt. Insbesondere steigt die Volatilität des Beschäftigungsniveaus, wohingegen dessen Persistenz mit zunehmendem Parameterwert abnimmt.
... In fact, estimates for both parameters differ widely across studies. For example Veracierto (2002) finds the unconditional volatility of the technology shock to be σ = 0.056, while Cooper and Haltiwanger (2006) finds that the unconditional volatility, σ = 0.30. Conditional volatility estimates are even harder to find in the literature. ...
... As with the volatility of the idiosyncratic productivity process, there is no consensus on the estimate for the autocorrelation parameter either. For example Veracierto (2002) estimates the autocorrelation of the idiosyncratic shock to be 0.83, while Cooper and Haltiwanger (2006) estimate a higher autocorrelation parameter of 0.885. Gomes (2001) and Khan and Thomas (2010) calibrate the autocorrelation parameter to be 0.65, to match the persistence of the investment process. ...
This paper studies the effects of changes in uncertainty on optimal leverage and investment in a dynamic firm-financing model in which firms have access to complete markets subject to collateral constraints. Entrepreneurs finance projects with their net worth and by issuing state-contingent securities, which have to be collateralized with physical capital. An increase in uncertainty leads to deleveraging, as entrepreneurs reduce their demand for external financing to be able to hedge the larger shocks. Initially deleveraging leads to a drop in investment. Investment recovers as entrepreneurs build up net worth and transition into an environment with high uncertainty. Changes in uncertainty have large quantitative effects on optimal leverage and investment dynamics. Financial innovation amplifies the effects of uncertainty shocks.
... The answer is that, since the firm must balance constantly the operating results with the results on capital account, it cannot afford to stay in business because the rise in the interest rate renders capital loses higher than operating profits. This is exactly the Veracierto (2002) effect of irreversibility that was mentioned above. ...
... The results from one experiment showed that, when the interest rate rises above a certain level, the scrapping firm exits form its industry and absorbs the losses due to the early abandonment of the undepreciated value of its capital stock. This corroborates the finding by Veracierto (2002) regarding the channel through which investment irreversibility affects capital policies . Another experiment showed that, if in addition to interest rate, the price elasticity of demand for output produced by the scrapping firm shifts in the same direction, the exit of the scrapping firm from its industry occurs at an even lower rate of interest. ...
The emphasis of capital theory in recent decades has moved away from the implications of useful life as an important economic variable and has turned on the microeconomic and macroeconomic consequences of investment irreversibilities. Thus, the voluminous literature that has developed ignores the marked difference between replacement and scrapping and glosses over their significant implications for microeconomic and aggregate dynamics. This paper highlights the gains in explanatory power that result when useful life, replacement and scrapping are placed in the center of the analysis. It does so by considering an economy with two representative firms that differ only in that the one applies replacement and the other scrapping. Among other interesting findings, at the microeconomic level it turns out that the demand for replacement investment is not invariant with respect to the type of capital policy being applied, whereas at the macroeconomic level it is shown that we cannot obtain consistent aggregates of capital stock and replacement investment.
... 3 Some of these contributions abstract from entry and exit. See for example the business cycle theories of Veracierto (2002), Khan andThomas (2003, 2008) and Bachman and Bayer (2009a,b), as well as the asset pricing model by Zhang (2005). Others do not. ...
... This is the case for the possibility that the occasional synchronization in the timing of establishments' investment may influence aggregate dynamics when nonconvex capital adjustment costs lead establishments to adjust capital in a lumpy fashion. SeeVeracierto (2002) andKhan andThomas (2003, 2008). ...
How important are firm entry and exit in shaping aggregate dynamics? We address this question by characterizing the equilibrium allocation in Hopenhayn (1992)’s model of equilibrium industry dynamics, amended to allow for investment in physical capital and aggregate fluctuations. We find that entry and exit propagate the effects of aggregate shocks. In turn, this results in greater persistence and unconditional variation of aggregate time-series. In the aftermath of a positive productivity shock, the number of entrants increases. The new firms are smaller and less productive than the incumbents, as in the data. As the common productivity component reverts to its unconditional mean, the new entrants that survive become progressively more productive, keeping aggregate efficiency higher than in a scenario without entry or exit. We also find that both the mean and variance of the cross-sectional distribution of firm-level productivity are counter-cyclical, in spite of the assumption that innovations to firm-level productivity are i.i.d. and orthogonal to aggregate shocks. This happens because of selection: the idiosyncratic productivity of the marginal entrant is lower in expansion than during recessions. Since idiosyncratic productivity is mean-reverting, mean and variance of the distribution of productivity growth are pro-cyclical.
... Conventional neoclassic theory assumes that firms make frequent small adjustments to their production technologies based on the surrounding market conditions (Doms and Dunne, 1998). However, empirical studies that used firm-level evidence find that adjustment costs are significantly large, so that firms tend to wait to adjust their capital (Veracierto, 2002, Thomas, 2002. ...
The UK is experiencing a period of low productivity growth. Although exacerbated by the
financial crisis of 2008, the underlying trend is longer and more persistent. Trend labour
productivity growth has been declining since the mid-1960s. Conventional understandings fall short of explaining the reasons behind this decline. The quality and availability of energy has been proposed as one driver of productivity growth. However, the links between energy and productivity are mediated by many factors and the relationship is contested.
This report aims to expand conventional understandings of productivity by exploring the
literatures which relate productivity to the availability, production and use of energy in the
economy. The report is the result of a survey, a desk-based literature review, and a
participatory mapping process (Boehnert et al 2019). We provide an introduction to key
theoretical issues regarding productivity analysis and review work on the historical
relationship between energy and labour productivity. We then review 6 channels through
which it has been proposed that energy and productivity may be related. They are: 1) Capital; 2) Prices; 3) Energy Consumption; 4) Energy Return on Energy Invested; 5) Economic Structure; and 6) Climate Change. Key findings and research gaps are summarised below.
Key Finding 1: There are numerous potential links between energy and productivity
• Researchers have proposed a variety of links between energy and productivity. Key
suggested links include the way that capital uses energy, and the way that economic
actors respond to energy prices. There may also be more indirect links, particularly
through climate change and the quality of the energy supply. Links often cut across
physical and social aspects of economic systems.
Key Finding 2: There is insufficient empirical evidence to prove or disprove many of the
proposed links.
• While many researchers suggest that energy and productivity are linked, there is
relatively little consensus in the empirical literatures either confirming or rejecting
these views. In some cases (notably the relationship between capital and energy), we
do not appear to have robust methodologies for making empirical assessments.
Key Finding 3: Mitigating against the negative impacts of energy use may require
transformative change.
• Fossil fuel energy use drives climate change, which is itself likely to reduce productivity
levels. Reductions in the quality of available energy may also impact productivity in a
number of ways. Mitigating these impacts could require transformative changes in the
way we use energy, and potentially also a rethinking of productivity growth itself.
... Changes in real wages and interest rates imply dramatic reductions in the volatility of aggregate investment and large increases in its persistence sufficient to match the serial correlation in the data. Perhaps most important is the result that, in general equilibrium, the persistence and skewness of aggregate investment rates are 2 As carefully explained by Caballero (1999), models with investment irreversibilities, such as Bertola and Caballero (1994) and Veracierto (2002), do not generate lumpy plant investment nor the corresponding amplification of aggregate investment demand. essentially unaffected by nonconvex capital adjustment costs. ...
... 2 Veracierto (1998), examining investment irreversibilities, Þnds similar results. ...
... However, we could increase the cash ratio only by 3ppt all else equal, thus confirming a fundamental limitation to generating precautionary saving through this channel. One reason for this failure is that once the resale value of capital goes down below 0.85, firms in the model never disinvest capital for liquidity reason (see Veracierto (2002)), making no material difference for liquidity hoarding. declines from 0.8 to 0.5. ...
This paper explores the hypothesis that the rise in intangible capital is a fundamental driver of the secular trend in US corporate cash holdings over the last decades. Using a new measure,we show that intangible capital is the most important firm-level determinant of corporate cash holdings. Our measure accounts for almost as much of the secular increase in cash since the 1980s as all other determinants together. We then develop a new dynamic model of corporate cash holdings with two types of productive assets, tangible and intangible capital. Since only tangible capital can be pledged as collateral, a shift toward greater reliance on intangible capital shrinks the debt capacity of firms and leads them to optimally hold more cash in order to preserve financial flexibility. In the model, firms with growth options tend to hold more cash in anticipation of (S,s)-type adjustments in physical capital because they want to avoid raising costly external finance. We show that this mechanism is quantitatively important, as our model generates cash holdings that are up to an order of magnitude higher than the standard benchmark and in line with their empirical averages for the last two decades. Overall, our results suggest that technological change has contributed significantly to recent changes in corporate liquidity management.
... The data we use are derived from the US Quarterly Census of Employment and Wages for the period 1992Q1 gregate inflation (Fuhrer and Moore (1995), Mankiw and Reis (2002)). Similarly, Veracierto's (2002) early study of the special case of irreversible investment found numerically that the model failed to capture the sluggishness of average capital changes-aggregate investment. (See also Christiano and Todd (1996).) ...
Labor market frictions are able to induce sluggish aggregate employment dynamics. However, these frictions have strong implications for the source of this propagation: they distort the path of aggregate employment by impeding the flow of labor across firms. For a canonical class of frictions, we show how observable measures of such flows can be used to assess the effect of frictions on aggregate employment dynamics. Application of this approach to establishment microdata for the United States reveals that the empirical flow of labor across firms deviates markedly from the predictions of canonical labor market frictions. Despite their ability to induce persistence in aggregate employment, firm‐size flows in these models are predicted to respond aggressively to aggregate shocks, but react sluggishly in the data. The paper therefore concludes that the propagation mechanism embodied in standard models of labor market frictions fails to account for the sources of observed employment dynamics.
... Hence, our characterization of symmetry in the distributional dynamics formalizes the intuition gleaned from Golosov and Lucas' numerical analysis. A more recent literature has emphasized the role of equilibrium adjustment in market prices in unwinding the aggregate effects of lumpy adjustment (see House, 2014;Khan and Thomas, 2008;Veracierto, 2002 ). It is important to note that the neutrality result in Proposition 2 is quite distinct from these channels. ...
This paper studies the analytics of a canonical model of lumpy microeconomic adjustment. We provide a novel characterization of the implied aggregate dynamics. In general, the distribution of firm outcomes follows a simple and intuitive law of motion that links aggregate outcomes to rates of adjustment. Analytical approximations reveal, however, that the aggregate dynamics are approximately invariant to a relevant range of adjustment costs. This neutrality is an aggregation result that emerges from a symmetry property in the distributional dynamics, independent of market equilibrium considerations. Quantitative illustrations confirm these results for parameterizations used in the employment and price adjustment literatures.
... Our work is related to a number of other areas of research. Several authors have found that in general equilibrium, irreversibility is important for macro aggregates following level shocks and increases in general uncertainty (Gilchrist and Williams (2005), Bloom, Bond, and Reenen (2007), and Bachmann, Caballero, and Engel (2010)), although these findings are not unchallenged (Veracierto (2002), Thomas (2002), and Khan and Thomas (2008)). ...
... Effective business relations can have a positive impact on economic growth by increasing both the rate of KEYWORDS Business conditions (Bcs); oil; error correction model (Ecm) investment and the productivity of investment (Dixit & Pyndick, 1994;Pyndick, 1991). Thomas (2002) and Veracierto (2002) find that in general equilibrium models, the impact of non-convex investment costs on the business cycle may be small. Arouri (2011) mentions that oil price changes effect macroeconomic events, investment costs, firms' production structures and unemployment, consumption situation, monetary policies interest rates and inflation. ...
This study aims to research the empirical relationship between business conditions (BCs) and crude oil prices by employing a time series analysis for a panel of regions. BCs have been proxied by real income and real industrial production (IND) as advised in the relevant literature. Results suggest that economic activity and industrial value added are in a long-term relationship with oil price movements in the selected countries and regions. Gross domestic product (GDP) and IND are significantly affected by oil prices worldwide. Real income converges to long-term paths significantly, but at low levels through the channel of oil price movements. Oil price has a negative impact on business activities in some countries while it has a positive impact in others. Therefore, the sign of coefficient of oil prices on business conditions has found significant in this research study.
... Since, in the context of a model of lumpy investment, transitory movements in the bene…t from investment expenditures are more likely to shift the adjustment hazard than 1 See Caballero (1999) for a survey. 2 Veracierto (1998), examining investment irreversibilities, …nds similar results. 2 shocks to total factor productivity, we explore their contribution to the generation of aggregate nonlinearities. ...
This paper is the result of a conversation with John Leahy; we are grateful to him for suggesting the topic to us. We would also like to thank Ricardo Caballero and Tony Smith for a series of helpful discussions. In addition we owe thanks to seminar participants at the University of California-Riverside, the Iowa City Midwest Macro meetings, the Society for Economic Dynamics meetings in San Jose, the
... However, the aggregate effects of irreversibility are more ambiguous. For example, Veracierto (2002) suggests that investment irreversibilities do not play a significant role for aggregate fluctuations. This paper does not consider aggregate shocks and aggregate fluctuations, but finds that one aggregate effect of asset liquidity is the equilibrium increase in the efficiency of the users of the assets. ...
Almost all real asset transactions occur in decentralized markets, where trading frictions could inhibit the efficiency of asset allocations and depress asset prices. In this paper, I first empirically investigate how asset illiquidity generates frictions that affect asset allocations and prices. Using data on commercial aircraft, I find that more liquid aircraft have: 1) higher turnover; 2) higher capacity utilization; 3) lower dispersion of utilization levels; 4) higher mean prices; and 5) lower dispersion of transaction prices. These patterns indicate that illiquidity increases the option value of holding on to an illiquid asset when the profitability of its user declines. I then construct a bilateral search model with multiple assets to theoretically inves-tigate which conditions generate the observed patterns of allocations and prices. When a seller meets a buyer at a rate that is an increasing function of the number of sellers, the model matches all empirical findings.. I am grateful to Pierre-Olivier Weill and to my colleagues at Yale for comments and suggestions, to Todd Pulvino for providing some of the data used in this paper, and to Jessica Jiang and Alistair Wilson for help with the research.
... This type of adjustment cost is often called a partial investment irreversibility and it is included in many corporate finance and macroeconomics papers, including Abel and Eberly (1994) and Veracierto (2002). The above definition of the firm's dividend says that the dividend, d, is defined as what the firm owns at the end of the period, e(k, n; z, r), minus what the firm keeps for the next period as its equity, n ′ , and the adjustment cost, (1 − τ c )g(k ′ , k). ...
In this paper, I investigate the cross-sectional determinants of corporate capital structure using a general equilibrium model with endogenous firm dynamics, a realistic tax environment, and financial frictions. I find that the equilibrium firm distribution in the model replicates fairly well the distribution of corporate capital structure as well as the relationship between capital structure, profitability, and firm size in the data. The key mechanisms here are economies of scale and two types of productivity shocks: persistent and transitory. The counterfactual experiment using the model implies, among other things, that tax benefits have relatively small effects on corporate capital structure choice compared with default costs and the costs of outside equity, including the dividend tax. It also reveals that the effects of those frictions on corporate capital structure choice are highly interrelated with each other.
... In this paper, we document the magnitude of these effects. This paper is thus also related to the literature on the assessment of the short-term impact of shocks (technological or others) on growth, since capital retirement influences the expected rate of return of investment (see Veracierto, 2002). In the literature, capital retirement is mainly looked at from a macroeconomic perspective. ...
This empirical analysis assesses the determinants of firms’ capital retirement. Particular attention is paid to the impact of the business cycle and the capital usage intensity. Compared to previous studies, we directly control for the capital utilization and disentangle the short-run mechanisms from the long-run ones. The analysis is carried out with an original and large firm-level dataset. The main results of the analysis may be summarized as follows: (i) the retirement rate increases during slowdowns and decreases during booms. This corresponds to a countercyclical capital retirement; (ii) the capital retirement rate increases with the capital usage intensity in the long run. This corresponds to a wear and tear effect, which is small compared to the countercyclical one; (iii) the
capital retirement rate increases with the average age of capital; (iv) the profit rate and the wage cost per capita do not have a significant impact on the retirement rate.
... In macroeconomics, the notion of investment irreversibility provides the traditional mechanism through which changes in uncertainty a¤ect economic activity; see for example, Bernanke (1983); Dixit and Pindyck (1994); and Caballero and Pindyck (1996). Although economically intuitive, the e¤ect of uncertainty on aggregate investment can be theoretically ambiguous, depending on the assumptions regarding the initial accumulation of capital, market structure, and the equilibrium setting (e.g., Abel (1983), Abel and Eberly (1996), and Veracierto (2002)). As a result, the literature on irreversible investment lacks a clear consensus regarding the direction of the impact on economic activity from an increase in uncertainty. ...
The canonical framework used to price risky debt implies that the payo¤ structure of levered equity resembles the payo¤ of a call option, while the bondholders face a pay-o¤ structure that is equivalent to that of an investor writing a put option. As a result, an increase in payo¤ uncertainty bene…ts equity holders at the expense of bondholders, a feature of the debt contract with two potentially important implications for macro-economic outcomes: First, to the extent that …rms face signi…cant frictions in …nancial markets, an increase in the bond risk premium implies an increase in the cost of capital and hence a reduction in investment— in such environment, uctuations in uncertainty can have a signi…cant e¤ect on investment, absent any investment irreversibility or managerial risk aversion. Second, a reduction in the supply of credit stemming from an increase in uncertainty will hamper an e¢ cient reallocation of capital and cause an endogenous decline in total factor productivity (TFP), thereby inducing a decline in economic activity. This paper analyzes— both empirically and theoretically— how uc-tuations in macroeconomic uncertainty interact with …nancial market imperfections in determining real economic outcomes. Using both aggregate time-series and …rm-level data, we …nd strong evidence supporting the notion that …nancial frictions play a major role in shaping the uncertainty-investment relationship. We then develop a tractable general equilibrium model in which individual …rms face time-varying aggregate uncer-tainty and imperfect capital markets when issuing risky bonds and equity to …nance investment projects. We calibrate the uncertainty process using micro-level estimates of shocks to the …rms' pro…ts and show that the combination of uncertainty shocks and …nancial frictions can generate uctuations in economic activity, which are obser-vationally equivalent to TFP-driven business cycles.
... In this paper we analyze the dynamic e¤ects of lumpy adjustments in capital and labour onto the aggregate economy. Investigating the e¤ects of non-convexities in capital adjustment, Veracierto (2002) and Khan and Thomas (2008) found no e¤ect from …rm level lumpiness on aggregate variables in a general equilibrium setting. This …nding has been further con…rmed by Reiter et al. (2008) in a monetary model. ...
We analyze the dynamic effects of lumpy factor adjustments at the firm level onto the aggregate economy. We find that distinguishing between capital and labour as lumpy factors within the production function result in very different dynamics for aggregate output, investment and labour in an otherwise standard real business cycle model. Lumpy capital leaves the RBC dynamics mainly unchanged, while lumpy labour allows for persistence and an inner propagation within the model in form of hump-shaped impulse responses. In addition, when modeling lumpy adjustments on both investment and labour, the aggregate effects are even stronger. We investigate the mechanisms underlying these results and identify the elasticity of factor supply as the most important element in accounting for these differences.
... 14 In these papers we extended the (S, s) literature to incorporate stochastic adjustment costs and estimate a structural model via maximum likelihood. 15 See Veracierto (2002) for a similar conclusion in a model of irreversible investment. Table 1a in CW (2004). ...
Cooper and Willis (2003) is the latest in a sequence of criticisms of our methodology for estimating aggregate nonlinearities when microeconomic adjustment is lumpy. Their case is based on "reproducing" our main findings using artificial data generated by a model where microeconomic agents face quadratic adjustment costs. That is, they supposedly find our results where they should not be found. The three claims on which they base their case are incorrect. Their mistakes range from misinterpreting their own simulation results to failing to understand the context in which our procedures should be applied. They also claim that our approach assumes that employment decisions depend on the gap between the target and current level of unemployment. This is incorrect as well, since the "gap approach" has been derived formally from at least as sophisticated microeconomic models as the one they present. On a more positive note, the correct interpretation of Cooper and Willis's results shows that our procedures are surprisingly robust to significant departures from the assumptions made in our original derivations.
Capital reallocation is procyclical and an economic boom has a cleansing effect by shifting the distribution of firms from low quality to high quality. We explain these facts by modeling search frictions for used capital in the business cycle. The paper characterizes the stochastic equilibrium analytically to prove that the liquidity and the price of reallocated capital are procyclical endogenously. We calibrate the model and construct proxies in the data for the unemployment rate of capital and the time on the market. These two variables have a strong positive relationship in both the model and the data. This article is protected by copyright. All rights reserved
We build a three-state general equilibrium model of the aggregate labor market that features both standard labor supply forces and labor market frictions. Our model matches key features of the cyclical properties of employment, unemployment, and nonparticipation as well as those of gross worker flows across these three labor market states. Our key finding is that shocks to labor market frictions play a dominant role in accounting for labor market fluctuations. This is in contrast to the focus of the traditional RBC literature, which emphasized how employment fluctuations arise as a consequence of labor supply responses to price changes induced by TFP shocks.
We study the effects of uncertainty on corporate leverage adjustments with respect to investment spikes and find that overlevered and underlevered firms behave very differently in response to the combination of uncertainty and investment spikes. Overlevered firms facing high uncertainty converge to their targets substantially faster, whereas their counterparts facing low uncertainty tend to deviate from their targets. However, underlevered firms facing low uncertainty fully adjust to their targets, while underlevered firms facing high uncertainty adjust their leverage more slowly. We find that real options and transitory debt are channels that can account for various aspects of these leverage dynamics. JEL classification: G31, G32, G33, D21, D81, D92 a We would like to thank
The first chapter studies the impact of globalization on the income gaps between the rich and the poor. This paper presents a new piece of
empirical evidence showing that executive-to-worker pay ratio is higher among exporting firms than non-exporting firms. It then builds a model with heterogeneous firms, occupational choice, and executive compensation to model analytically and assess quantitatively the impact of globalization on the income gaps between the rich and the
poor. The key insight of the model is that the "gains from trade" are not distributed evenly within the same firm. The compensation of an executive is positively linked to the size of the firm, while the wage paid to the workers is determined in a country-wide labor market. Any extra profit earned in the foreign markets benefits the executives more than an average worker. The model is then calibrated to create a counterfactual world where the only source of change is the access to the global markets. Model simulations show that around one-third of the surge in top income shares in the U.S. can be
attributed to globalization between 1988 and 2008. The second chapter, joint with Ruediger Bachmann, studies the relationship between nonconvex capital adjustment costs at the firm level and aggregate
investment dynamics. We study this question quantitatively with a two-sector lumpy investment model with inventories. We find that with inventories, nonconvex capital adjustment costs dampen and propagate the reaction of investment to shocks: the initial response of fixed capital investment to productivity shocks is 50% higher with frictionless adjustment than with the calibrated capital adjustment frictions, once inventories are introduced. The last chapter, joint with Ruediger Bachmann and Andrei Levchenko, presents a set of novel empirical facts that the aggregate U.S. imports, exports, and real exchange rate show conditional heteroscedasticity. We estimate two ARCH family time series models and show that conditional heteroscedasticity is statistically significant for imports and
exports between 1970 and 2012, and for the real exchange rate between 1973 and 2012.
The objective of this paper is to assess both the aggregate growth effects and the distributional consequences of financial liberalization as observed in Thailand from 1976 to 1996. A general equilibrium occupational choice model with two sectors, one without intermediation and the other with borrowing and lending is taken to Thai data. Key parameters of the production technology and the distribution of entrepreneurial talent are estimated by maximizing the likelihood of transition into business given initial wealth as observed in two distinct datasets. Other parameters of the model are calibrated to try to match the two decades of growth as well as observed changes in inequality, labor share, savings and the number of entrepreneurs. Without an expansion in the size of the intermediated sector, Thailand would have evolved very differently, namely, with a drastically lower growth rate, high residual subsistence sector, non-increasing wages but lower inequality. The financial liberalization brings welfare gains and losses to different subsets of the population. Primary winners are talented would-be entrepreneurs who lack credit and cannot otherwise go into business (or invest little capital). Mean gains for these winners range from 17% to 34% of observed, overall average household income. But liberalization also induces greater demand by entrepreneurs for workers resulting in increases in the wage and lower profits of relatively rich entrepreneurs, of the same order of magnitude as the observed overall average income of firm owners. Foreign capital has no significant impact on growth or the distribution of observed income.
Why is capital reallocation across firms procyclical and more volatile than investment? To answer the question, this paper develops a tractable dynamic general equilibrium model. In the model, firms face idiosyncratic productivity risks, and they are subject to partial capital irreversibility and financing constraints. Partial capital irreversibility generates selling delays. I show that financing constraints interact with irreversibility and prolong the delays. As a result, reallocation activity is slowed down during recessions when financing constraints are tighter. Less reallocation also persistently depresses total factor productivity.
In the past three recessions, two major features of the business cycle have changed. First, employment now lags output growth, leading to jobless recov-eries. Second, average labor productivity (ALP) has become acyclical or even countercyclical. This paper proposes a joint explanation for both facts. I develop a quantitative model in which …rms streamline and restructure during recessions. The model captures the idea that …rms grow "fat" during booms but then quickly "restructure" during recessions by laying o¤ their unproductive workers. Firms then enter the recovery with a greater ability to meet expanding demand without hiring additional workers. This model explains 55% of the decline in the procycli-cality of ALP observed in the data and generates a 4 quarters long jobless recovery after the Great Recession. for helpful comments. I am also grateful for comments from seminar participants at MOOD, the Cologne Macro Workshop, Yale University Macroeconomics Lunch and Summer Workshop. I gratefully acknowledge the support of an NSF graduate research fellowship.
This paper uses Hungarian data to estimate the structural parameters of a firm-level investment model with a rich structure of adjustment costs, and analyzes whether non-convex adjustment costs have any effect on the aggregate investment dynamics. The main question addressed is whether aggregate profitability shocks (as a result of monetary policy, for example) lead to different aggregate investment dynamics under non-convex and convex adjustment costs. The main finding is that while non-convex adjustment costs make investment lumpier at the firmlevel, they lead to a more flexible adjustment pattern at the aggregate level. This is because the model is calibrated to have the same proportion of inactive (i.e. non-investing) firms under convex and non-convex adjustment costs, but the average size of new investment of active firms is higher under non-convex adjustment costs.
We use asset pricing insights to study importance of micro-level frictions for aggregate quantities. In our model, the relevant stochastic variable is a stationary growth rate (necessary to produce high Sharpe Ratios in a Long Run Risk world), as opposed to a trend-stationary level of productivity. This naturally implies a heteroscedastic and timedependent aggregate investment rate; contributing to the recent debate between Khan and Thomas (2008) and Bachmann, Caballero, and Engel (2010), we find that non-convex costs are not necessary to match these moments. Our best model, combining convex and nonconvex costs, matches aggregate macro-economic and micro-level investment moments, as well as the High Sharpe Ratio of equity.
In this paper I study a new business cycle fact recently documented by Bachmann and Bayer (2011): the dispersion of the distribution of investment rates across firms is procyclical. Using data from German firm, the authors find a correlation coefficient between the standard deviation of investment distribution and the cyclical component of output of 0.45. They also report a correlation coefficient for US economy of 0.33. Using a model similar to Khan and Thomas's (2003), that is standard to heterogeneous firms literature, I obtain a correlation coefficient of 0.57. In the model I also consider a government sector that collects taxes on corporate profits. In such model, with a corporate tax of 23.5%, which corresponds to German economy, I obtain a correlation coefficient of 0.46 and when I consider a corporate tax rate of 18.79% that corresponds to US economy I find a correlation coefficient of 0.51.
The purpose of this paper is to apply a methodology to test for the existence and distinguish between types of financial constraints for entrepreneurs who want to start a business but are not wealthy enough to finance the startup costs by themselves, the paper uses sur vey data from Nicaragua to test the implications of two well known models of occupational choice with different underlying assumptions about financial constraints. The methodology used in this paper fol lows the guidelines of Robert Townsend's "Algorithm for Policy Based Research and Research Based Policy" and was supervised by him.
Our paper examines the impact of heterogeneous trading opportunities on the distribution of asset shares and wealth in an equilibrium model. We distinguish between "passive" traders who hold fixed portfolios of equity and bonds, and "active" traders who adjust their portfolios to changes in the investment opportunity set. In the presence of non-participants, the fraction of active traders is critical for asset prices, because only these traders respond to variation in state prices and hence help to clear the market, not the fraction of agents that participate in asset markets. We develop a new method for computing equilibria in this class of economies. This method relies on an optimal consumption sharing rule and an aggregation result for state prices that allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market. In a calibrated version of our model, we show that the heterogeneity in trading opportunities allows for a closer match of the wealth and asset share distribution as well as the moments of asset prices.
Purpose
– The purpose of this paper is to propose a method to plan entry and exit times of a project delivering cash flows influenced by business cycles. In this setting, the profit yield by the project are driven by a geometric Brownian motion whose mean and variance switch between a finite number of regimes.
Design/methodology/approach
– In the existing literacy, an activity is started or aborted once that the current potential profit jumps over a barrier. Due to operational delays, this investment rule can be inefficient in practice. For this reason, the approach developed in this work relies on the assumption that a manager chooses entry and exit times that maximize on average the expected discounted profits.
Findings
– In this model, entry and exit times are then solutions of a simple non‐linear system of equations. The author also shows how the parameters ruling the switching regime cash flows associated to a project can be inferred from the stock market quotes of a company, active in the same sector of activities. To illustrate the tractability of the model, the author applies it to a project in the healthcare industry.
Originality/value
– The model proposed in this paper is tractable for a wide set of investment/disinvestment problems.
In the standard bond-pricing framework (e.g., Merton [1974]), the return function of holders of risky corporate debt is a concave function of the firm's stochastic return, implying that a mean-preserving spread is associated with an increase in the bond risk premium. This feature of the standard debt contract has two important implications for the relationship between uncertainty and investment. First, to the extent that firms face significant frictions in credit markets, the rise in the bond risk premium implies an increase in the cost of capital and hence a reduction in investment; in such environment, uncertainty can have a significant effect on investment dynamics absent any investment irreversibility or managerial risk aversion. Second, if credit market frictions are an im-portant mechanism through which uncertainty affects investment, then the inclusion of the bond risk premium in an empirical investment specification should attenuate the direct impact of uncertainty on investment. Using both the aggregate time-series and firm-level data, we test these two hypotheses and find strong support for the view that the relationship between uncertainty and investment is influenced importantly by the presence of credit market frictions. We then develop a tractable general equilib-rium model in which firms issue risky bonds and equity in imperfect capital markets to finance investment projects. We calibrate the uncertainty process using firm-level esti-mates of shocks to the firms' profits and show that the model successfully explains the cross-sectional and time-series properties of bond risk premiums and their comovement with uncertainty and aggregate investment. provided outstanding research assistance. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System.
This paper analyzes the implications of plant-level dynamics over the business cycle. We first document basic patterns of entry and exit of U.S. manufacturing plants, in terms of employment and productivity between 1972 and 1997. We show how entry and exit patterns vary during the business cycle, and that the cyclical pattern of entry is very different from the cyclical pattern of exit. We find that entry is more cyclical than exit, and that the entrants' size and productivity are more cyclical than these of exiting plants. Second, we build a general equilibrium model of plant entry, exit, and employment. We compare its predictions to the data. In our model, plants enter and exit endogenously, and the size and productivity of entering and exiting plants are also determined endogenously. Finally, we explore the policy implications of the model. Imposing a firing tax that is constant over time can destabilize the economy by causing fluctuations in the entry rate. Entry subsidies are found to be effective in stabilizing the entry rate and output.
Interpreting accruals as working capital investment, we hypothesize that firms rationally adjust their investment to respond to discount rate changes. Consistent with the optimal investment hy-pothesis, we document that (i) the predictive power of accruals for future stock returns increases with the covariations of accruals with past and current stock returns, and (ii) adding investment-based factors into standard factor regressions substantially reduces the magnitude of the accrual anomaly. High accrual firms also have similar corporate governance and entrenchment indexes as low accrual firms. This evidence suggests that the accrual anomaly is more likely to be driven by optimal investment than by investor overreaction to excessive growth or over-investment.
We use panel data for Korean Manufacturing plants to document substantial dispersion in the average product of capital, three times greater than dispersion in the average product of other factors. If one interprets this as evidence of misallocation (dispersion in the marginal product of capital), aggregate productivity losses are substantial, about 40 percent. We evaluate the ability of a model of industry dynamics in which firms face non-convex capital adjustment costs, financing frictions, and uninsurable investment risk to account for the dispersion in the marginal product of capital. We show that the frictions necessary to reconcile the model's predictions with the data are large and account for the bulk of within-plant time-series variance in the average product of capital. They are incapable, however, of sustaining the large and persistent differences in the marginal product of capital in the cross-section and thus account for a small fraction (less than 10%) of the misallocation in the data.
Most models incorporating …rm heterogeneity assume that idiosyncratic productivity follows an AR(1) process. However, there remains substantial disagreement on the persistence parameter, with estimates ranging from a unit root to a nearly iid component. This paper uses the information embedded in …rms' investment decisions to estimate the productivity process: investment reacts more to a permanent shock than to a transitory shock. I apply this methodology to a sample drawn from Compustat, using a method of moments estimator. The estimates give an important role to permanent shocks. I study the implications of these estimates in a general equilibrium model of …rm dynamics. Mistaking permanent shocks for persistent shocks can lead to incorrect inferences regarding, for instance, the e¤ect of a friction on aggregate productivity. As an example of application of this methodology, I also study the trends and cycles in …rm-level volatility.
We present an analytically tractable general equilibrium business cycle model that features micro-level investment lumpiness. We prove an exact irrelevance proposition which provides sufficient conditions on preferences, technology, and the fixed cost distribution such that any positive upper support of the fixed cost distribution yields identical equilibrium dynamics of the aggregate quantities normalized by their deterministic steady state values. We also give two conditions for the fixed cost distribution, under which lumpy investment can be important: (i) The steady-state elasticity of the adjustment rate is large so that the extensive margin effect is large. (ii) More mass is on low fixed costs so that the general equilibrium price feedback effect is small. Our theoretical results may reconcile some debate and some numerical findings in the literature.
This empirical analysis aims at assessing the effect of the economic climate and the intensity of capital utilisation on companies’ capital retirement behaviour. It is conducted using individual company data, as well as original data on the degree of utilisation of production factors. The sample includes 6,998 observations over the period 1996-2008. This database is, to our knowledge, unique for the empirical analysis of the intensity of capital utilisation on firms’ capital retirement behaviour. We adjust for endogeneity biases by means of instrumental variables. The main results obtained from the estimation of capital retirement models may be summarised as follows: i) The retirement rate decreases with the variations in cyclical pressures measured by the changes in output and the workweek of capital; this relation corresponds to a countercyclical decelerator effect on capital retirement; ii) The capital retirement rate increases with the structural intensity of capital utilisation; this effect, which corresponds to a wear and tear one, is nevertheless small compared to the decelerator one; iii) The profit rate does not have a significant impact on the retirement rate. Compared with the existing literature, here mainly Mairesse and Dormont (1985), the contribution of these results is to show, through the use of unique survey data, that the effect of the intensity of capital utilisation on capital retirement is structurally positive, via a wear and tear effect, and cyclically negative, via a decelerator effect which completes that already taken into account via the effect of changes in value added.
This paper analyzes a stochastic general equilibrium model similar to the one by Cox, Ingersoll and Ross (1985) but in which investment is irreversible; i.e. a general equilibrium model with an endogenous and non-decreasing supply of a risky asset. The case of log-utility is explicitly solved. We find that equilibrium money market returns become negative at a critical point at which investment becomes profitable and in times of high volatility even though marginal product of capital is positive. This 'liquidity trap' is caused by an excess demand for short term assets as a precaution for worse times that does not match with the supply of irreversible long term investment opportunities. We also address the question whether there exists an option premium of waiting to invest. With logarithmic utility this is not the case.
This paper shows that with (partial) irreversibility higher uncertainty reduces the responsiveness of investment to demand shocks. Uncertainty increases real option values making firms more cautious when investing or disinvesting.
This is confirmed both numerically for a model with a rich mix of adjustment costs, time-varying uncertainty, and aggregation
over investment decisions and time and also empirically for a panel of manufacturing firms. These “cautionary effects” of
uncertainty are large—going from the lower quartile to the upper quartile of the uncertainty distribution typically halves
the first year investment response to demand shocks. This implies the responsiveness of firms to any given policy stimulus
may be much weaker in periods of high uncertainty, such as after the 1973 oil crisis and September 11, 2001.
This book provides an overview of the modern theory and empirics of business cycles. Written by one of the pioneering authors in this field, it examines the notion of a business cycle and discusses alternative approaches to modeling. Arguably, one of the most important debates in this literature has been the issue of “matching” a business cycle to the data. In their original contribution, Kydland and Prescott (1982) proposed the method of calibration as a way of examining the implications of a business cycle model; yet, even at its inception, this approach came under criticism from a variety of sources. This monograph will examine some of these criticisms and discuss alternative approaches that have been put forward. More generally, it will discuss what lies ahead for modern business cycle theory.
Using plant-level data, I show that the dispersion of total factor productivity in U.S. durable manufacturing is greater in recessions than in booms. This cyclical property of productivity dispersion is much less pronounced in non-durable manufacturing. In durables, this phenomenon primarily reflects a relatively higher share of unproductive firms in a recession. In order to interpret these findings, I construct a business cycle model where production in durables requires a fixed input. In a boom, when the market price of this fixed input is high, only more productive firms enter and only more productive incumbents survive, which results in a more compressed productivity distribution. The resulting higher average productivity in durables endogenously translates into a lower average relative price of durables. Additionally, my model is consistent with the following business cycle facts: procyclical entry, procyclical aggregate total factor productivity, more procyclicality in durable than non-durable output, procyclical employment and countercyclicality in the relative price of durables and the cross section of stock returns.
We study the determinants of aggregate corporate investment in the U.S. We use accounting identities to develop a system in which (i) news about future cash flows and news about future discount rates are directly estimated, thus mitigating measurement problems with Tobin's q, the variable that is typically used in investment regressions; and (ii) current cash flow shocks and news about the future are jointly estimated recognizing their interdependence. We present three empirical findings. First, the lion's share of investment variation is driven by current cash flow shocks instead of news about the future. This happens because neither cash holdings nor net payout (including external financing) varies enough to break the link between earnings shocks and investment. Second, current earnings shocks are not forward-looking, suggesting that the bulk of investment is not forward-looking. Third, the same patterns hold even for the largest and most liquid firms.
This paper provides a unified treatment of the theory of optimal growth when investment is irreversible and output from production is uncertain. Under a convex technology and fairly general assumptions on the random environment, it is shown that optimal policies are monotonic and converge to a unique limiting distribution which is independent of the initial stock. The paper concludes with a comparison of optimal policies in the presence and absence of irreversibility.