Lumpy Investment and Corporate Tax Policy

In the presence of both convex and nonconvex capital adjustment costs in a dynamic general equilibrium model, corporate tax policy generates both intensive and extensive margin effects via the channel of marginal Q. Its impact is determined largely by the strength of the extensive margin effect, which, in turn, depends on the cross‐sectional distribution of firms. Depending on the initial distribution of firms, the economy displays asymmetric responses to tax changes. Moreover, an anticipated increase in the future investment tax credit reduces investment and adjustment rate initially.     

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 investment goods.     

Investment Dynamics with Information Costs

Investment in physical capital at the microlevel is infrequent and large, or lumpy. The most common explanation for this is that firms face nonconvex physical adjustment costs. The model developed in this paper shows that information costs make investment lumpy at the microlevel, even in the absence of nonconvex adjustment costs. When collecting and processing information are costly, the firm optimally chooses to do it sporadically and to be inactive most of the time. This behavior results in infrequent and possibly large capital adjustments. The model fits plant‐level investment rate moments well, and it also matches some higher order moments of aggregate investment rates.     

Financing constraints, irreversibility, and investment dynamics

We develop a model of an industry with many heterogeneous firms that face both financing constraints and irreversibility constraints. We use this model to examine the cyclical behavior of aggregate fixed investment, variable capital investment, and output in the presence of persistent idiosyncratic and aggregate shocks. Our model yields three main results. First, the effect of the irreversibility constraint on fixed capital investment is reinforced by the financing constraint. Second, the effect of the financing constraint on variable capital investment is reinforced by the irreversibility constraint. Finally, the interaction between the two constraints is key for explaining why input inventories and material deliveries of US manufacturing firms are so volatile and procyclical, and also why they are highly asymmetrical over the business cycle.     

Inventory investment and the cost of capital

We examine the relation between inventory investment and the cost of capital in the time series and the cross section. We find consistent evidence that risk premiums, rather than real interest rates, are strongly negatively related to future inventory growth at the aggregate, industry, and firm levels. The effect is stronger for firms in industries that produce durables rather than nondurables, exhibit greater cyclicality in sales, require longer lead times, and are subject to more technological innovation. We then construct a production-based asset pricing model with two types of capital, fixed capital and inventories, to explain these empirical findings. Convex adjustment costs and a countercyclical price of risk lead to negative time series and cross-sectional relations between expected returns and inventory growth.     

‘Wait-and-See’ business cycles?

Are shocks to firms' profitability risk, propagated by physical capital adjustment costs, a major source of business cycle fluctuations? This paper studies this question using a heterogeneous-firm dynamic stochastic general equilibrium model, where firms face fixed capital adjustment costs. Surprise increases in idiosyncratic risk lead firms to adopt a ‘wait-and-see’ policy for investment. The model is calibrated using a German firm-level data set with broader coverage than comparable U.S. data sets. The main result is that time-varying firm-level risk through ‘wait-and-see’ dynamics is unlikely a major source of business cycle fluctuations.     

Lumpy investment,sticky prices,and the monetary transmission mechanism

Smoothness in aggregate capital accumulation is a necessary condition for New-Keynesian (NK) models to imply a quantitatively relevant monetary transmission mechanism (see, e.g., [Woodford, 2005. Firm-specific capital and the new Keynesian Phillips curve. International Journal of Central Banking 2, 1–46]). Can that aggregate smoothness be entertained in the context of an NK model featuring lumpy plant-level investment? Our answer is yes. Imperfect competition in goods markets and/or sticky prices are identified as economic mechanisms which render lumpy investment relevant in general equilibrium.     

Investment Adjustment Costs: An Empirical Assessment

We evaluate the empirical evidence for costs that penalize changes in investment using U.S. industry data. In aggregate models, such investment adjustment costs have been introduced to help account for a variety of business cycle and asset market phenomena. So far no attempt has been made to estimate these costs directly at a disaggregated level. We consider an industry model with investment adjustment costs and estimate its parameters using generalized methods of moments. The findings indicate small costs associated with changing the flow of investment at the industry level. The weighted average of the industry elasticities with respect to the shadow price of capital, which depends inversely on the adjustment cost parameter, is eight times larger than the largest estimate reported in Levin et al. (2006) . We examine a variety of factors that may account for this discrepancy, but a substantial part of it remains unexplained. Our results therefore suggest that more caution is needed when giving policy advice that hinges on a structural interpretation of large investment adjustment costs.     

Testing financing constraints on firm investment using variable capital

We consider a dynamic multifactor model of investment with financing imperfections, adjustment costs and fixed and variable capital. We use the model to derive a test of financing constraints based on a reduced form variable capital equation. Simulation results show that this test correctly identifies financially constrained firms even when the estimation of firms’ investment opportunities is very noisy. In addition, the test is well specified in the presence of both concave and convex adjustment costs of fixed capital. We confirm empirically the validity of this test on a sample of small Italian manufacturing companies.     

Can Costs of Consumption Adjustment Explain Asset Pricing Puzzles?

We investigate Grossman and Laroque's (1990) conjecture that costs of adjusting consumption can account, in part, for the empirical failure of the consumption-based capital asset pricing model (CCAPM). We incorporate small fixed costs of consumption adjustment into a CCAPM with heterogeneous agents. We find that undetectably small consumption adjustment costs can account for much of the discrepancy between the observed variance of nondurable aggregate consumption growth and the predictions of the CCAPM, and can partially reconcile nondurable consumption data with the observed equity premium. We conclude that the CCAPM's implications are nonrobust to extremely small adjustment costs.     

Cyclical adjustment of capital requirements: A simple framework

We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.     

Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship

We analyze the role of risk aversion and intertemporal substitution in a simple dynamic general equilibrium model of investment and savings. Our main finding is that risk aversion cannot by itself explain a negative relationship between aggregate investment and aggregate uncertainty, as the effect of increased uncertainty on investment also depends on the intertemporal elasticity of substitution. In particular, the relationship between aggregate investment and aggregate uncertainty is positive even if agents are very risk averse, as long as the elasticity of intertemporal substitution is low. A negative investment-uncertainty relationship requires that the relative risk aversion and the elasticity of intertemporal substitution are both relatively high or both relatively low. We also show that the implications of our model are consistent with the available empirical evidence.     

A Model of the Confidence Channel of Fiscal Policy

This article presents a simple macroeconomic model where government spending affects aggregate demand directly and indirectly, through an expectational channel. Prices are fully flexible and the model is static, so intertemporal issues play no role. There are three important elements in the model: (i) fixed adjustment costs for investment, which create an inaction zone; (ii) noisy idiosyncratic information about the aggregate economy; and (iii) imperfect substitution among private goods and goods provided by the government. An increase in government spending raises demand for private goods and may prevent a coordination failure. The optimal level of government expenditure is high when the desired level of investment is low, which we interpret as a time of low economic activity.     

Where is the GE? Consumption Dynamics in DSGEs

We offer a partial equilibrium perspective on the behavior of consumption in dynamic stochastic general equilibrium (DSGE) models. We consider a benchmark dynamic general equilibrium model and show that a standard calibration implies that the real interest rate is essentially fixed. One manifestation of this feature is that, with separable preferences, the reaction of consumption to total factor productivity (TFP) shocks is flat: the random‐walk permanent income hypothesis holds almost exactly, pretty much as in a partial equilibrium consumption‐savings problem. These results help explain the prominent role of aggregate demand, and how it is achieved, in modern DSGE analysis.     

Habit formation and the persistence of monetary shocks

The dynamic effects and relative importance of monetary shocks in the US business cycle are studied using a sticky-price dynamic stochastic general equilibrium model with habit formation and capital adjustment costs. The model is estimated via maximum likelihood using data on output, real money balances, and the nominal interest rate. Econometric results indicate that the model has a strong internal propagation mechanism that can explain the persistent and hump-shaped response of US output and consumption to monetary shocks.     

The case for inflation stability

We evaluate the case for inflation stabilization in a New Keynesian (NNS) model that includes various frictions, capital accumulation and a variety of shocks. In such a model, price rigidity may provide the monetary authorities with an opportunity to improve upon the inefficient flexible price equilibrium via the suitable cyclical manipulation of real marginal costs. We find that such an opportunity is of limited value and that a strong case for perfect inflation stabilization remains. Policies that tolerate a small amount of inflation variability may outperform perfect inflation targeting when capital adjustment costs are low and the monetary distortion is substantial but only if prices are very flexible.     

Inventory Investment and the Empirical Phillips Curve

In this paper, we study the Calvo pricing models with finished goods inventory investment to demonstrate that the current inflation can be expressed as a function of the marginal cost of sales, not the marginal production cost, and expected future inflation. Under the assumption that the true aggregate marginal costs are not observable in actual data, we make use of equilibrium conditions for aggregate finished goods inventories to measure the time series of marginal costs, thereby leading to the construction of inflation series on the basis of the Phillips curve. Our results indicate the possibility of a successful fit of the empirical New Keynesian Phillips curve without relying on unit labor cost—a conventional measure of marginal production cost in the literature.     

Equilibrium Exhaustible Resource Price Dynamics

We develop equilibrium models of exhaustible resource markets with endogenous extraction choices and prices. Our analysis demonstrates how adjustment costs can generate oil and gas forward price dynamics with two factors, consistent with the behavior these commodities exhibit in the Schwartz and Smith (2000) calibration. Our two‐factor model predicts that stochastic volatility will arise in these markets as a natural consequence of production adjustments, however, and we provide supporting empirical evidence. Differences between endogenous price processes from our general equilibrium model and exogenous processes in earlier papers can generate significant differences in both financial and real option values.     

Delayed Adjustment and Persistence in Macroeconomic Models

Estimated impulse responses of investment and hiring typically peak well after the impact of a shock. Standard models with adjustment costs in capital and labor do not exhibit such delayed adjustment, but we argue that it arises naturally when we relax the assumption that the production technology is separable over time. This result, which holds for both convex and nonconvex cost functions, is strong enough to match the persistence observed in the data for reasonable parameter values. We discuss some evidence for our explanation and ways to test it.     

An open-economy new Keynesian Phillips curve for the U.K.

We estimate a pricing equation or “new Keynesian Phillips curve” (NKPC) obtained from a structural dynamic model of price setting based on Rotemberg [1982. Sticky prices in the United States. Journal of Political Economy 90(6), 1187-1211] and extended to capture employment adjustment costs and the openness of the United Kingdom. This model nests the baseline Galí and Gertler [1999. Inflation dynamics: a structural econometric analysis. Quarterly Journal of Economics 110, 127-159) and Sbordone [2002. Prices and unit labor costs: a new test of price stickiness. Journal of Monetary Economics 49, 265-292] relationship between inflation and marginal cost in the limiting case of no employment adjustment costs, no impact of relative prices of imported inputs on real marginal cost and a constant equilibrium markup. Our findings indicate that each of our modifications to the baseline NKPC model is important for U.K. data, so that inflation in the U.K. is explained both by changes in employment and by changes in real import prices, in general, and real oil prices, in particular. External competitive pressures also seem to affect U.K. inflation via their impact on the equilibrium price markup of domestic firms.