Volatility of Investment

Consumption (C), investment (I), government spending (G-T) and net export (X-I) are the major components of aggregate demand (Y). Economists have been particularly interested in the volatility of investment.

Both Fig.1and 2 suggest that there is a general positive relationship between GDP and investment, more importantly, investment is much more volatile. E.g. in the 1990-91 recession, investment spending declined more than 10 percent while consumption spending declined only 0.6 percent.

Before trying to explain the reason(s), one should understand the nature of investment. An economy¡¯s resources can either be consumed immediately, or added to the fixed capital stock in order to use at a later date. Investment is referred to as the production and purchase of capital goods, i.e. man-made means of productions such as machinery and factories. It is an important determinants of economic growth, thus its volatility matters a lot.

One of the common theories is the concept of ¡°...