Understanding investment irreversibility in general equilibrium

Abstract

In general equilibrium, irreversibility affects both the wealth of consumers and the return on assets. As long as the inter-temporal elasticity of substitution is realistically low, irreversibility not only prevents capital destruction, but it also induces capital creation. Furthermore, under certain conditions, irreversibility raises the risk premium by increasing the variability of consumption and market portfolio. These issues are dealt in a simple model of investment irreversibility with multiple types of capital. Its tractability allows for analytical results which explain the contrast between the consequences of irreversibility for individual markets and the consequences of irreversibility for the whole economy. (JEL E22, G12).