LUMPY INVESTMENT IN DYNAMIC GENERAL EQUILIBRIUM Ruediger Bachmann

Microeconomic lumpiness matters for macroeconomics. According to our DSGE model, it explains roughly 60% of the smoothing in the investment response to aggregate shocks. The remaining 40% is explained by general equilibrium forces. The central role played by micro frictions for aggregate dynamics results in important history dependence in business cycles. In particular, booms feed into themselves. The longer an expansion, the larger the response of investment to an additional positive shock. Conversely, a slowdown after a boom can lead to a long lasting investment slump, which is unresponsive to policy stimuli. Such dynamics are consistent with US investment patterns over the last decade. More broadly, over the 1960-2000 sample, the initial response of investment to a productivity shock with responses in the top quartile is 60% higher than the average response in the bottom quartile. Furthermore, the reduction in the relative importance of general equilibrium forces for aggregate investment dynamics also facilitates matching conventional RBC moments for consumption and employment. Ruediger Bachmann Yale University Department of Economics PO Box 208268 New Haven, CT 06520-8268 [email protected] Ricardo J. Caballero MIT Department of Economics Room E53-252a Cambridge, MA 02142-1347 and NBER [email protected] Eduardo M.R.A. Engel Yale University Department of Economics PO Box 208268 New Haven, CT 06520-8268 and NBER [email protected]