Is Lumpy Investment Relevant for the Business Cycle?

_________________________________________________________________________ Previous research has suggested that discrete and occasional plant-level capital adjustments have significant aggregate implications. In particular, it has been argued that changes in plants’ willingness to invest in response to aggregate shocks can at times generate large movements in total investment demand. In this study, I re-assess these predictions in a general equilibrium environment. Specifically, assuming nonconvex costs of capital adjustment, I derive generalized (S,s) adjustment rules yielding lumpy plant-level investment within an otherwise standard equilibrium business cycle model. In contrast to previous partial equilibrium analyses, model results reveal that the aggregate effects of lumpy investment are negligible. In general equilibrium, households’ preference for relatively smooth consumption profiles offsets changes in aggregate investment demand implied by the introduction of lumpy plant-level investment. As a result, adjustments in wages and interest rates yield quantity dynamics that are virtually indistinguishable from the standard model. _____________________________________________________________________________________ *Department of Economics, University of Minnesota, 1035 Heller Hall, 271 – 19th Avenue South, Minneapolis, MN 55455; [email protected]. I thank John Cochrane, Aubhik Khan and Robert King for a series of discussions and suggestions that have substantially improved the quality of this work. I am also grateful to an anonymous referee, Marianne Baxter, Robert Chirinko, Andrew John, Patrick Kehoe, Timothy Kehoe, John Leahy, Edward Prescott and Stanley Zin, as well as seminar participants at the Board of Governors, Boston College, Calgary, Carnegie Mellon, the Federal Reserve Bank of Philadelphia, GSB-Chicago, Houston, Minnesota, Virginia, Wharton, the February 1999 NBER Economic Fluctuations and Growth meetings, and the 1999 Midwest Macroeconomics, Society for Economic Dynamics and NBER Summer Institute meetings for helpful comments. Any remaining errors are my own. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.