Lumpy Investment, Sectoral Propagation, and Business Cycles

This paper proposes a model of endogenous fluctuations in investment. A monopolistic producer has an incentive to invest when the aggregate demand is high. This causes a propagation of investment across sectors. When the investment follows an (S,s) policy, the propagation size can exhibit a significant fluctuation. We characterize the probability distribution of the propagation size, and show that its variance can be large enough to match the observed investment fluctuations in a partial equilibrium of product markets. We then implement this mechanism in a dynamic general equilibrium model to explore an investmentdriven business cycle. By calibrating the model with the SIC 4-digit level industry data, we numerically show that the model replicates the basic structure of the business cycles.