Irreversibility and Aggregate InvestmentInvestment is often irreversible, in that installed capital has little or no value unless used in production. In the presence of ongoing uncertainty, an individual firm's irreversible investment policy optimally alternates short bursts of positive gross investment to periods of inaction, when the installed capital stock is allowed to depreciate. The behavior of aggregate investment series is characterized by sluggish, continuous adjustment instead. We argue in this paper that aggregate dynamics should be interpreted in terms of unsynchronized irreversible investment decisions by heterogenous firms, rather than in terms of ad-hoc adjustment cost functions in a representative-agent framework. We propose a closed-form solution for a realistic model of sequential irreversible investment, characterize the aggregate implications of microeconomic irreversibility and idiosyncratic uncertainty, and interpret U.S. data in light of the theoretical results. |
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actual investment adjustment costs aggregate investment aggregate shocks aggregate uncertainty Appendix approximation Barry Eichengreen Bertola and Caballero Brownian motion Bureau of Economic Caballero 1990 Caballero and Engel characterized Clarida Cobb-Douglas coefficient cointegrating constant elasticity cost of capital cross sectional distribution cross-sectional distribution defined denote depreciate derived desired capital stock dG(t differential dk(t Economic Research empirical distribution endogenous equation exogenous firm firm's problem Fumio Hayashi functional equations functional forms Giuseppe Bertola idiosyncratic sources idiosyncratic uncertainty implied individual units installed capital stock investment irreversibility investment policy investment rate investment series investment/capital ratio irreversibility constraint Jacob Mincer K¹(t kª(t leads and lags marginal revenue product microeconomic National Bureau NBER observed obtain optimal irreversible investment parameters price of capital probability distribution product of capital regressors relevant serial correlation sin(bz solution sources of uncertainty standard deviation stock of capital unit's variable variance-covariance matrix Wiener process yields zero