The New Investment Theory and Aggregate Dynamics

This paper develops a dynamic general-equilibrium model of capital adjustments under monopolistic competition. Investments are partially irreversible. The model includes microfoundations for consumption decisions and capital-adjustment strategies. The effects of the model parameters on the optimal capital-adjustment strategy are determined analytically. A major result is that the aggregate net investment is proportional to the difference between the desired and previous aggregate capital. The speed of adjustment decreases with the cost of reversibility, is invariant to the shares of labor and capital, and increases with the level of macroeconomic uncertainty. However, the latter effect is not quantitatively important. (Copyright: Elsevier)