Investment in Inflationary Economies, Issues 96-105
International Monetary Fund, Western Hemisphere Department, 1996 - Inflation (Finance) - 27 pages
The paper presents a model of irreversible investment under uncertainty, where investment takes place whenever a threshold level of marginal returns is reached. The threshold depends positively on price volatility; a change from high to low inflation induces an upward capital stock adjustment. In economies that move in and out of temporary stabilizations, the observed effect is a negative inflation-investment correlation that replicates previous empirical findings, due to purely short-term dynamics. I study how this correlation is affected by the expected duration of each regime. Empirical evidence from ten inflationary economies confirms the predictions of the model.
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aggregate investment Argentina average inflation Brazil Caballero and Pindyck changes in inflation changes of regime characteristic equation coefficients correlation between inflation countries Ecuador effect on investment empirical evidence entry equation expected duration fixed effects geometric Brownian motion high and low high inflation hyperinflation increases industry price inflation affects investment inflation and investment inflation level inflation rate series inflation series inflation tax inflationary economies INFN International Monetary Fund investment decision investment rate irreversible investment kšk lagged values levels of inflation low inflation low volatility marginal returns Monte Carlo methods negative correlation Panel Regressions periods Pindyck and Solimano price stability rational investor regime switch relative price volatility returns to capital returns to investment Sample Eqn Section short-run short-term dynamics significant simulating SINF2 R2 AIC standard deviation standard errors Table threshold behavior threshold effect induced threshold level Threshold Values tion volatility of returns volatility parameter WPSINF zedt