Explaining investment dynamics in U.S. manufacturing: a generalized (S; s) approach

Abstract

In this paper we derive a model of aggregate investment that builds from the lumpymicroeconomic behavior of firms facing stochastic fixed adjustment costs. Instead of theŽ.standard sharp S, s bands, firms’ adjustment policies take the form of a probability ofŽ.adjustment adjustment hazard that responds smoothly to changes in firms’ capacity gap.The model has appealing aggregation properties, and yields nonlinear aggregate timeseries processes. The passivity of normal times is, occasionally, more than offset by thebrisk response to large accumulated shocks. Using within and out-of-sample criteria, wefind that the model performs substantially better than the standard linear models ofinvestment for postwar sectoral U.S. manufacturing equipment and structures investmentdata.