Animal Spirits, Lumpy Investment, and the Business Cycle

Abstract

Empirical literature on investment and output dynamics is characterized by two robust stylized facts at the macro level. First, investment is considerably more volatile than output. Second, fluctuations of output and investment are highly synchronized. Furthermore, at the micro level, firm investment appears to be very lumpy. In this paper, we ask whether the two macroeconomic stylized facts above can be explained in terms of bounded rationality (i.e. "animal spirits") in firm investment behavior and the ensuing lumpiness in investment patterns. To address this question, we present an evolutionary, agent-based, model of industry dynamics and firm investment behavior. The economy is composed of consumers and firms, who belong to two industries. Firms in the first industry perform R&D and produce heterogeneous machine tools. Firms in the second industry invest in new machines and produce a consumption good. Lumpiness of firm investment is not grounded on non-convex adjustment costs, but on "animal spirits": manufacturing firms invest only if they expect a large growth in the demand for their product. Simulations show that the model is able to generate - as emergent properties - Keynesian endogenous business cycles and to reproduce the foregoing empirical macro output-investment regularities at the business cycle frequencies.Evolutionary Models, ACE Models, Animal Spirits, Lumpy Investment, Output Fluctuations, Endogenous Business Cycles