Large open economies and fixed costs of capital adjustment

Capital reallocation creates excess volatility in investment in many two-country open economy models. Convex adjustment costs to capital have become a standard tool to deal with this. However, current microeconomic investment models feature non-convex adjustment costs as the dominant friction. This paper analyzes fixed costs to capital adjustment in a two-country business cycle model and finds that fixed costs unlike in closed economies dampen aggregate investment volatilities. Moreover, convex adjustment costs can serve as a stand-in for these fixed adjustment costs when one is interested in aggregate dynamics only. Yet, the mapping between fixed and quadratic adjustment costs co-depends on other model parameters. (C) 2015 The Authors. Published by Elsevier Inc. This is an open access article under the CC BY-NC-ND license (http://creativecommons.orgilicensesiby-nc-nd/4.0/).