Time-varying Investment Dynamics in the USA

We study the time-varying effects of Tobin's q and cash flow on investment dynamics in the USA using a vector autoregression model with drifting parameters and stochastic volatilities estimated via Bayesian methods. We find a significant variation over time of the response of investment to shocks in both variables. The time-varying sensitivity of investment to a shock in Tobin's q (cash flow) decreased (increased) since the early 1960s through the early 1980s, increased (decreased) since the early 1980s through the early 2000s, and it has decreased (increased) importantly again since then. Thus, the time-varying response of investment to a shock to Tobin's q has been almost the mirror image to the time-varying response of investment to a shock to cash flow. This implies that Tobin's q and cash flow represent both complementary and alternative sources of information needed to understand short-run investment behavior.