Lumpy Investment, Sectoral Propagation, and Business Cycles

Lumpy Investment, Sectoral Propagation, and
Business Cycles

Makoto Nirei*

Santa Fe Institute

May 10, 2004

Abstract

This paper proposes a model of endogenous fluctuations in investment. A
monopolistic producer has an incentive to invest when the aggregate demand
is high. This causes a propagation of investment across sectors. When the
investment follows an (S,s) policy, the propagation size can exhibit a significant
fluctuation. We characterize the probability distribution of the propagation size,
and show that its variance can be large enough to match the observed investment
fluctuations in a partial equilibrium of product markets. We then implement this
mechanism in a dynamic general equilibrium model to explore an investment-
driven business cycle. By calibrating the model with the SIC 4-digit level industry
data, we numerically show that the model replicates the basic structure of the
business cycles.

1 Introduction

This paper concerns a propagation mechanism in investment across sectors. The large
fluctuation in investment is often considered as a driving force of business cycles. Also
the investment fluctuation is characterized by the synchronized oscillation across sec-
tors. We propose a model of investment propagation which quantitatively explains this
phenomenon and identifies the parameters at work.

*This paper is based on my Ph.D. dissertation submitted to Department of Economics, University
of Chicago. I am grateful to Lars Hansen, Fernando Alvarez and Jose Scheinkman for their advice. I
have benefited from comments by Samuel Bowles, Doyne Farmer, Xavier Gabaix, Jess Gaspar, Luigi
Guiso, John Leahy, Toshihiko Mukoyama, Andrea Tiseno, and Hiroshi Yoshikawa.

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