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Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach

Ricardo J. Caballero and Eduardo M. R. A. Engel
Econometrica
Vol. 67, No. 4 (Jul., 1999), pp. 783-826
Published by: The Econometric Society
Stable URL: http://www.jstor.org/stable/2999458
Page Count: 44
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach
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Abstract

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

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