Putty-clay and investment: A business cycle analysis

This paper develops a general equilibrium model with putty-clay technology, investment irreversibility, and variable capacity utilization. Low short-r un capital-labor substitutability induces the putty-clay effect of a tight link between changes in capacity and movements in employment and output. Pe rmanent shocks to technology or factor prices generate a hump-shaped respon se of hours, persistence in output growth, and positive comovement in the f orecastable components of output and hours. Capacity constraints result in asymmetric responses to large shocks with recessions deeper than expansions . Estimation of a two-sector model supports a significant role for putty-cl ay capital in explaining business cycle and medium-run dynamics.