Essays on the business cycle

"Much as I hate to spoil my story by announcing its plot in advance, this paper is too long and involved to be clear otherwise. It deals with growth of investment and of capital stock subject to depreciation and periodic replacement. " E. Domar The above citation is taken from a piece, Depreciation Replacement and Growth, written by Evsey Domar in 1953. A few years later he will write Depreciation Replacement and Growth - and Fluctuations. The theme of the replacement of capital and its role for fluctuations is old. So why write paper at the beginning of the 21st century on this same subject? My answer is that this matter has become increasingly important in time. Never before have pieces of productive assets been replaced at the pace that firms today renew their computers and related equipment. This has caused a dramatic shift in the nature of depreciation: from an exogenous to an endogenous phenomenon. The first two essays of this thesis focus on the acceleration of replacement and its consequences for the propagation of nominal shocks in a neoclassical economy. To paraphrase Domar it deals with fluctuations of investment and of capital stock subject to depreciation and endogenous replacement. In the first essay I document the extent of the acceleration in replacement that the US economy has experienced in the last three decades and derive a few implications for the investment behavior of firms in a partial equilibrium setup. The main result is that firms can now respond to demand shifts by postponing or accelerating the replacement of their capital stock.