NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Irreversibility and Aggregate Investment

Giuseppe Bertola, Ricardo J. Caballero

NBER Working Paper No. 3865
Issued in October 1991
NBER Program(s):   EFG

Investment is often irreversible, in that installed capital has little or no value unless used in production. In the presence of ongoing uncertainty, an individual firm's irreversible investment policy optimally alternates short bursts of positive gross investment to periods of inaction, when the installed capital stock is allowed to depreciate. The behavior of aggregate investment series is characterized by sluggish, continuous adjustment instead. We argue in this paper that aggregate dynamics should be interpreted in terms of unsynchronized irreversible investment decisions by heterogenous firms, rather than in terms of ad-hoc adjustment cost functions in a representative-agent framework. We propose a closed-form solution for a realistic model of sequential irreversible investment, characterize the aggregate implications of microeconomic irreversibility and idiosyncratic uncertainty, and interpret U.S. data in light of the theoretical results.

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Document Object Identifier (DOI): 10.3386/w3865

Published: Review of Economic Studies, vol 61, no 2, pp 223-246, April 1994

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