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What Do Micro Data Reveal About the User Cost Elasticity?: New Evidence on the Responsiveness of Business Capital Formation

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Author Info

  • Robert S. Chirinko

    (The Jerome Levy Economics Institute)

  • Steven M. Fazzari

    (The Jerome Levy Economics Institute)

  • Andrew P. Meyer

    (The Jerome Levy Economics Institute)

Abstract

The price sensitivity of business investment spending is a central element in economic analysis. A substantial response of capital spending to its user cost, which combines interest, tax, and depreciation rates with relative prices, is critical to evaluating the effectiveness of monetary policy, deficit reduction, and tax reform. In spite of this central role, however, the supporting evidence for a substantial user cost elasticity (UCE) is modest. Several important concerns suggest a downward bias in elasticities estimated from the aggregate data typically employed in UCE research. These biases may arise from firm heterogeneity, measurement error, capital market frictions, and simultaneity. While such biases are theoretically plausible, their empirical importance remains to be substantiated. With a particularly rich data set, containing over 26,000 observations, this paper explores what can be learned about the UCE from micro data. Investment and firm-level control variables are taken from an extensive panel of Compustrat forms. To construct the user cost, we tap a new data source that provides variation across firms as well as across time. A number of the econometric biases mentioned above have a substantial impact on the estimated UCE. After correcting for the biases, we obtain a precisely estimated but small value for the UCE of about -0.25. The effects of capital gain tax cuts and the "flat-tax" proposal on investment are evaluated with this estimated UCE.

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File URL: http://128.118.178.162/eps/mac/papers/9805/9805011.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 9805011.

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Length: 60 pages
Date of creation: 28 May 1998
Date of revision:
Handle: RePEc:wpa:wuwpma:9805011

Note: Type of Document - Acrobat File; prepared on IBM PC ; to print on PostScript; pages: 60; figures: included
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Web page: http://128.118.178.162

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  1. Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
  2. Fazzari, Steven M & Hubbard, R Glenn & Petersen, Bruce C, 1988. "Investment, Financing Decisions, and Tax Policy," American Economic Review, American Economic Association, vol. 78(2), pages 200-205, May.
  3. Steven M. Fazzari & Benjamin Herzon, 1998. "Capital Gains Tax Cuts, Investment, and Growth," Macroeconomics 9811006, EconWPA.
  4. M Arellano & O Bover, 1990. "Another Look at the Instrumental Variable Estimation of Error-Components Models," CEP Discussion Papers dp0007, Centre for Economic Performance, LSE.
  5. Robert S. Chirinko, 1993. "Business fixed investment spending: a critical survey of modeling strategies, empirical results, and policy implications," Research Working Paper 93-01, Federal Reserve Bank of Kansas City.
  6. Stephen Oliner & Glenn Rudebusch & Daniel Sichel, 1993. "New and old models of business investment: a comparison of forecasting performance," Working Paper Series / Economic Activity Section 141, Board of Governors of the Federal Reserve System (U.S.).
  7. Zvi Griliches & Jerry A. Hausman, 1984. "Errors in Variables in Panel Data," NBER Technical Working Papers 0037, National Bureau of Economic Research, Inc.
  8. Alan S. Blinder & Louis J. Maccini, 1991. "Taking Stock: A Critical Assessment of Recent Research on Inventories," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 73-96, Winter.
  9. Robert S. Chirinko & Huntley Schaller, 1993. "Why does liquidity matter in investment equations?," Research Working Paper 93-13, Federal Reserve Bank of Kansas City.
  10. Urga, G., 1992. "The Econometrics of Panel Data: A Selective Introduction," Economics Series Working Papers 99151, University of Oxford, Department of Economics.
  11. Chirinko, Robert S, 1988. "Business Tax Policy, the Lucas Critique, and Lessons from the 1980's," American Economic Review, American Economic Association, vol. 78(2), pages 206-10, May.
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Cited by:
  1. Austan Goolsbee, 2000. "The Importance of Measurement Error in the Cost of Capital," NBER Working Papers 7558, National Bureau of Economic Research, Inc.

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