Kinked Adjustment Costs and Aggregate Dynamics

Abstract

Because adjustment costs may make infrequent corrections preferable to partial continuous adjustment, microeconomic units often behave quite differently from representative agents in aggregate dynamic models. Idiosyncratic uncertainty precludes perfect coordination of microeconomic adjustment and explains the much smoother behavior of aggregate variables. This paper reviews and extends models of optimal adjustment under uncertainty and of dynamic aggregation, and argues that unsynchronized microeconomic adjustment can provide a sensible, structural interpretation of macroeconomic time series. A simple statistical representation of the process followed by aggregate variables in the presence of microeconomic adjustment costs and of idiosyncratic uncertainty is shown to satisfactorily explain the behavior of U.S. durable consumption data.