Investment, capacity utilization, and the real business cycle (original) (raw)

1988, The American Economic Review

This paper adopts Keynes' view that shocks to the marginal efficiency of investment are important for business fluctuations, but incorporates it in a neoclassical framework with endogenous capacity utilization. Increases in the efficiency of newly produced investment goods stimulate the formation of "new" capital and more intensive utilization and accelerated depreciation of "old" capital. Theoretical and quantitative analysis suggests that the shocks and transmission mechanism studied here may be important elements of business cycles. In the real-business cycle models of the type developed by Finn Kydland and Edward Prescott (1982), and John Long and Charles Plosser (1983), the cycles are generated by exogenous shocks to the production function. A stylized version of the main mechanism working in these models can be described as follows. Dynamic optimizing behavior on the part of agents in the economy implies that both consumption and investment react positively to these direct shocks to output. Since the marginal productivity of labor is directly affected, employment is also procyclical. The resulting capital accumulation provides a channel of persistence, even if the technology shocks are serially uncorrelated. Hence, these productivity shocks are able to generate, from a neoclassical framework, co-movements of macroeconomic variables and persistence of fluctuations that conform to those typically observed during business cycles. In contrast with the mechanism described above, where investment reacts to changes in output, the present paper adopts John Maynard Keynes' (1936) view that it is shocks to the marginal efficiency of investment that are important for generating output fluctuations. However, these shocks are incorporated here in a neoclassical framework where the rate of capital utilization is endogenous. In the present model, a positive shock to the marginal efficiency of investment stimulates the formation of "new" capital and the more intensive utilization and accelerated depreciation of "old" capital. The main operating characteristics of the proposed model are analyzed in order to gain an understanding of the transmission mechanism of the shocks. Of particular theoretical interest are the qualitative characteristics of the pattern of co-movements and persistence effects permissible in this framework Then, a quantitative analysis of the model is performed to assess its ability to mimic the observed pattern of postwar-U.S. business cycle fluctuations. This is carried out by constructing a parametrized version of the model for which the exact joint probability distribution of the endogenous and exogenous variables is numerically computed. Using this distribution, a set of second moments for the artificial economy's variables-reflecting their co-movements and persistence-is computed and compared with that characterizing U.S. data. Fluctuations in investment played a key role in Keynes' view of the trade cycle. There, shifts in the marginal efficiency of investment impact on investment, aggregate demand and therefore, given the disequilibrium in the labor market, employment and output. The quintessential case of this type is when there is an increase in the