Is Lumpy Investment Relevant for the Business Cycle?

Abstract

The lumpiness of investment activity at the plant level is a well‐established fact. Previous research has suggested that such discrete and occasional 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 reassess 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, and lumpy investment appears largely irrelevant for equilibrium business cycle analysis.