Federal Reserve Bank of Minneapolis Research Department Staff Report 306 Nonconvex Factor Adjustments in Equilibrium Business Cycle Models: Do Nonlinearities Matter? *

Recent empirical analysis has found nonlinearities to be important in understanding aggregated investment. Using an equilibrium business cycle model, we search for aggregate nonlinearities arising from the introduction of nonconvex capital adjustment costs. We find that, while such costs lead to nontrivial nonlinearities in aggregate investment demand, equilibrium investment is effectively unchanged. Our finding, based on a model in which aggregate fluctuations arise through exogenous changes in total factor productivity, is robust to the introduction of shocks to the relative price of investment goods. * This paper is the result of a conversation with John Leahy; we are grateful to him for suggesting the topic to us. We would also like to thank Ricardo Caballero and Tony Smith for a series of helpful discussions. In addition we owe thanks to seminar participants at the would like to acknowledge the hospitality of the Federal Reserve Bank of Minneapolis. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or Philadelphia or the Federal Reserve System.