Maintenance Expenditures and Indeterminacy Under Increaing Returns to Scale, Federal Reserve Bank of San Fransisco Working Paper Series, WP

This paper develops a one-sector real business cycle model in which competitive firms allocate resources for the production of goods, investment in new capital, and maintenance of existing capital. Firms also choose the utilization rate of existing capital. A higher uti-lization rate leads to faster capital depreciation, while an increase in maintenance activity has the opposite effect. We show that as the equilibrium ratio of maintenance expenditures to GDP rises, the required degree of increasing returns for local indeterminacy declines over a wide range of parameter combinations. When the model is calibrated to match empirical evidence on the relative size of maintenance and repair activity, we find that local inde-terminacy (and belief-driven fluctuations) can occur with a mild and empirically-plausible degree of increasing returns–around 1.08