ADJUSTMENT COSTS

This article surveys the use of adjustment frictions in macroeconomic research, exploring the consequences of convex and non-convex adjustment costs for firm-level decisions and the dynamics of macroeconomic aggregates. The mechanics of these frictions are illustrated using several prominent examples including the partial adjustment model of employment, the q-theoretic investment model, and lumpy adjustment models of investment and employment. We also review the (S,s) inventory model, where stock accumulation is explained as the result of fixed delivery costs, and briefly discuss (S,s) decision rules arising from piecewise-linear costs in the context of capital irreversibility and firing taxes. Across a wide body of macroeconomic research, the interest in adjustment costs has been largely utilitarian. In designing theoretical models to organize our understanding of patterns observed in the data, we make hard choices about which of the many elements affecting the decisions of actual firms and households and the outcomes of their market interactions to include. Given their necessary simplicity, we often find that the predictions of the theoretical economies we are able to analyse are too stark relative to the behaviour observed in actual economies. Thus, in a variety of settings we have adopted adjustment costs in our economic laboratories to summarize omitted frictional elements that reduce, delay or protract changes in the demand and supply of final goods and their factor inputs in response to changes in economic conditions. In these few pages, we describe the mechanics of commonly used adjustment costs and briefly discuss their role in several leading macroeconomic applications. Since a comprehensive survey is beyond the scope of this article, many important applications have been excluded. However, where possible we direct the reader to influential research on these topics