INVESTMENT PLANNING COSTS AND THE EFFECTS OF FISCAL AND MONETARY POLICY. Susanto Basu and Miles S. Kimball. University of Michigan and NBER


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1 INVESTMENT PLANNING COSTS AND THE EFFECTS OF FISCAL AND MONETARY POLICY Susanto Basu and Miles S. Kimball University of Michigan and NBER
2 MAIN RESULTS. Show that a model with capital accumulation and sticky prices but no investment frictions has counterintuitive properties. Real interest rates rise with monetary expansion (Tobin, 955; King, 993) Increases in government purchases lower output and real interest rates in the short run Complements earlier work with J. Fernald on contractionary technology improvements 2. Suggest a friction that might help address both problems: Investment planning costs 3. Show that planning costs make the model more plausible Shortrun fiscal policy expansionary (restores Keynesian Cross logic) Real interest rate effect from monetary expansions Propagation of shocks matches data better 4. Qtheorystyle capital adjustment costs generally not a substitute for planning costs
3 WHY EXPENDITURE INERTIA? Supposing we just want to match evidence that money shocks have delayed effect on output Then we could think of mechanisms to create inertia in each element of private expenditure: Y = C + I + G ( + NX) OR More parsimoniously, could build inertia into production (e.g., make L costly to adjust, output precommitments) Y (, ) = F K L
4 But evidence says that G shocks have immediate output effect [RameyShapiro (998), BlanchardPerotti (22), MountfordUhlig (22), Perotti (24)] Then we need the inertia in expenditure, not production Investment inertia is consistent with micro evidence (Edge, 2; Lamont, 999) Complements consumption inertia; e.g., habit formation Macro effects akin to time to plan (Christiano and Todd, 996), not time to build need to slow down ordering the new investment goods
5 BUILDING BLOCKS OF THE MODEL Baseline: Basic RBC model, Calvo pricing. Capital accumulation; no investment frictions KingPlosserRebelo (988) utility Assume EIS (σ) less than (BasuKimball, 22). Implies C and N (labor) complements Real rigidities from: labor attachment, intermediate goods, concave demand curve Monopolists rent K and use attached N i to produce varieties Yi Y ZK N i α α i = i F Z is technology. F is the fixed cost. The local degree of returns to scale is Y + F Γ= Y
6 Distortionary taxation of capital and labour income: Bars indicate aftertax prices A = R A+ ( R δ ) K +Θ+ WN C + T Government balances budget period by period: ( ) G+ T = τ R δ K +Θ + τ WN K tax L For comparison with literature, marginal dg financed via lumpsum taxes, dt Money introduced via exogenouslyappended LM curve (With change of parameters, can accommodate contemporaneous Taylor rule)
7 BASIC STICKYPRICE MODEL: NO ADJUSTMENT COSTS Cost minimization by monopolists implies RK WN α = α Without adjustment costs, the real interest rate is α WN R = ( τ K ) δ α K where W is the pretax real wage Call the linearization of this equation the KE curve (Tobin/Sargent) Note: WN increasing in Y, so real interest rate positively linked with output!
8 The KEMP Diagram R MP KE R y y
9 An Expansionary Money Shock in the Basic Model R MP MP R KE R y y y
10 Linearized KE curve, with household FOC substituted ( ) ( R δ)( τk τk) ( ) η α η + + R R = ( τk) R y ( + η ) z σλ + ( τl τl) + k Γ( α) τl Γ( α). Shortrun y and R fall if. Technology, z, improves, 2. Government purchases rise (higher λ), or 3. Distortionary labour tax rate, τ L, falls! y and R fall with higher capital income taxation
11 Intuition: Another way of writing the capital market equilibrium condition: Y + F R = ( τ K ) α δ µ (). K where µ is the expost markup Positive real shocks usually reduce ( ),. MC Y, but with P a state variable, markup and hence distortion is higher
12 The Effect of a Positive Real Supply Shock Given a Constant Money Growth Rule R MP MP R KE KE R y y y
13 The Effect of a Positive Real Supply Shock Given a Taylor Rule and Sluggish Inflation R MP MP R KE KE R y y y
14 ADDING PLANNING COSTS Capital Rental Firms ( S ) t d Max e Rτ τ τ = RK K dt S t= Φ K subject to K = I δ K I = S γ I K, I given S is investment project starts, KΦ(S/K) is the planning adjustment cost function, and γ is the rate at which investment projects are completed. Φ is increasing and convex This Calvolike formulation has the advantage that there is good micro data on /γ (Edge, 2). The results are much more sensitive to choice of γ than to convexity of Φ Very small planning costs can generate significant delays with projects lasting about a year, a 6month delay requires costs such that a % increase in project starts raises overall investment costs by.96%
15 An Expansionary Money Shock with Output Inertia R MP MP KE R R y = y y
16 FIGURE 2. AR() POSITIVE GOVERNMENT SHOCK OUTPUT EMPLOYMENT.5.5 RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model INVESTMENT CONSUMPTION
17 2 FIGURE 2. AR() POSITIVE GOVERNMENT SHOCK (cont'd) BEFORE TAX RENTAL RATE AFTER TAX RENTAL RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model BEFORE TAX WAGE RATE AFTER TAX WAGE RATE
18 deviation from steady state, in % per year REAL INTEREST RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model .5 FIGURE 2. AR() POSITIVE GOVERNMENT SHOCK (cont'd) deviation from steady state, in % per year.5..5 INFLATION PRICE LEVEL .2 deviation from steady state, in % per year NOMINAL INTEREST RATE .5
19 .2 CAPITAL STOCK FIGURE 2. AR() POSITIVE GOVERNMENT SHOCK (cont'd) RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model 2.5 LAMBDA MARGINAL Q PROJECT STARTS
20 .5 OUTPUT FIGURE 5. PERMANENT MONEY SHOCK RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model 2.5 EMPLOYMENT INVESTMENT.5 CONSUMPTION
21 4 3 2 BEFORE TAX RENTAL RATE FIGURE 5. POSITIVE PERMANENT MONEY SHOCK (cont'd) RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model 3 2 AFTER TAX RENTAL RATE BEFORE TAX WAGE RATE 2 AFTER TAX WAGE RATE
22 deviation from steady state, in % per year FIGURE 5. POSITIVE PERMANENT MONEY SHOCK (cont'd) REAL INTEREST RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model 2 deviation from steady state, in % per year INFLATION PRICE LEVEL deviation from steady state, in % per year NOMINAL INTEREST RATE
23 .2 OUTPUT FIGURE 3. AR() LABOR TAX INCREASE.5 EMPLOYMENT RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model INVESTMENT CONSUMPTION
24 .5 FIGURE 3. AR() LABOR TAX INCREASE (cont'd) BEFORE TAX RENTAL RATE AFTER TAX RENTAL RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model BEFORE TAX WAGE RATE.5 AFTER TAX WAGE RATE
25 deviation from steady state, in % per year FIGURE 3. AR() LABOR TAX INCREASE (cont'd) REAL INTEREST RATE INFLATION.2 RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model. ADJUSTMENT COSTS Model .3 deviation from steady state, in % per year PRICE LEVEL deviation from steady state, in % per year NOMINAL INTEREST RATE
26 . FIGURE 3. AR() LABOR TAX INCREASE (cont'd) CAPITAL STOCK.3 LAMBDA RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model MARGINAL Q 2 PROJECT STARTS
27 FIGURE 4. AR() CAPITAL TAX INCREASE OUTPUT EMPLOYMENT. RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model.5 ADJUSTMENT COSTS Model INVESTMENT. CONSUMPTION
28 BEFORE TAX RENTAL RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model FIGURE 4. AR() CAPITAL TAX INCREASE AFTER TAX RENTAL RATE BEFORE TAX WAGE RATE.5 AFTER TAX WAGE RATE
29 deviation from steady state, in % per year FIGURE 4. AR() CAPITAL TAX INCREASE (cont'd) REAL INTEREST RATE RBC Model BASIC STICKY PRICE Model TIME TO PLAN Model ADJUSTMENT COSTS Model . deviation from steady state, in % per year 8 x 3 INFLATION PRICE LEVEL deviation from steady state, in % per year NOMINAL INTEREST RATE .
30 FIGURE 4. AR() CAPITAL TAX INCREASE (cont'd) CAPITAL STOCK LAMBDA.5 RBC Model Basic STICKY PRICE Model TIME TO PLAN ADJUSTMENT COSTS MODEL MARGINAL Q PROJECT STARTS
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