The Macroeconomics of Partial Irreversibility

• Authors: Isaac Baley.
• BSE Working Paper: 110784 | January 22
• Keywords: irreversibility , transitional dynamics , inaction , lumpiness , investment frictions , fixed adjustment costs , capital misallocation , Tobin's q , propagation , corporate taxes
• JEL codes: D30, D80, E20, E30
• irreversibility
• transitional dynamics
• inaction
• lumpiness
• investment frictions
• fixed adjustment costs
• capital misallocation
• Tobin's q
• propagation
• corporate taxes

We investigate the macroeconomic effects of partially irreversible investment arising from a wedge between the buying and selling price of capital. We derive sufficient statistics that characterize the implications of irreversibility for three long-run macroeconomic outcomes- capital allocation, capital valuation, and capital fluctuations. Measuring these statistics with investment microdata, we find that irreversibility distorts the allocation of capital, lowers capital valuation, and increases the persistence of capital fluctuations. Corporate income tax cuts, by lowering the deductibility of capital losses due to the price wedge, effectively increase irreversibility and structurally change long-run capital behavior.