Abstract: This paper provides a tractable general equilibrium model that can accommodate shocks and irreversibility constraints both at the firm and at the aggregate level. Under realistic conditions, irreversibility not only prevents capital destruction, but it also promotes capital creation. Moreover, irreversibility depresses risk-free rates, especially in booms, and magnifies risk premia, especially in downturns. In addition to the theoretical analysis, two numerical examples illustrate the quantitative effects of investment irreversibility in the face of either large rare depressions or mild frequent recessions.
JEL Classification: E22;E44