Adjustment Cost on Investment and Under-Utilization of Maximum Installed Capacity in South Korean Business Cycle - A Bayesian New Keynensian Model

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Abstract This study examines the effects of adjustment costs on investment and the under-utilization of maximum installed capacity within the South Korea using a New Keynesian business cycle with Bayesian approach. The New Keynesian business cycle model that incorporates both investment frictions as well as capital under-utilization. The model has been calibrated specifically for South Korea economy. The model estimation uses Markov Chain Monte Carlo (MCMC) methods along with the Metropolis-Hastings algorithm to draw samples from the posterior distributions parameters of the model. The fitness of the model is rigorously validated through several tests. It includes likelihood ratio tests, out-of-sample forecasting test. Policy metrics coefficient reveals that productivity shock has immense effects on investment dynamics and capacity utilization. The research includes a thorough examination of policy response coefficients, correlations among economic variables and variance decomposition. By examining these studies, it is clear that adjustment costs have a significant impact on economic fluctuations and it becomes crucial to consider these effects in policy formulation. The model’s robustness is verified through sensitivity analysis, which involves checking the convergence and efficiency of various MCMC simulations and varying degrees of mark-up price and wage shocks. This research provides valuable insights into how adjustment costs and policy responses shape the South Korean business cycle and provides implications for economic policy and management.