Lumpy Investment, Partial Adjustment and the Business Cycle: A Reconciliation.

Empirical research indicates that distributed lag specifications perform well in describing aggregate investment. Such specifications are typically rationalized through the assumption of convex adjustment costs that imply smooth partial adjustment of capital. However, much of the capital stock adjustment within individual production units is discrete and occasional. Neoclassical models of the business cycle preclude such lumpy factor adjustments. Furthermore, to replicate important volatilities and comovements of investment and output, these models must essentially eliminate convex adjustment costs. This paper uses an equilibrium generalized (S,s) model to reconcile lumpy establishment level investment and aggregate partial adjustment while maintaining business cycle performance. Furthermore, it illustrates the importance of general equilibrium considerations for the timing and magnitude of investment activity in generalized (S,s) models.