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UK Business Investment and the User Cost of Capital

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  • Colin Ellis
  • Simon Price

Abstract

Theory tells us that output, the capital stock and the user cost of capital are related. From the capital accumulation identity, it also follows that the capital stock and investment have a long-run proportional relationship. The dynamic structure thus implies a multicointegrating framework, in which separate cointegrating relationships are identifiable. This has been used to justify the estimation of investment equations embodying a reduced-form long-run relationship between investment and output (rather than between the capital stock and output). In this paper, a new investment equation is estimated in the full structural framework, exploiting a measure of the capital stock constructed by the Bank, and a long series for the cost of capital. A constant elasticity of substitution production function is assumed, and a well-determined estimate of the elasticity of substitution is obtained by a variety of measures. The robust result is that the elasticity of substitution is significantly different from unity (the Cobb-Douglas case), at about 0.45. Overidentifying restrictions on the long-run relationship are all accepted. Thus there is strong evidence for a significant effect from the user cost of capital. Copyright Blackwell Publishing Ltd and The Victoria University of Manchester, 2004.

Suggested Citation

  • Colin Ellis & Simon Price, 2004. "UK Business Investment and the User Cost of Capital," Manchester School, University of Manchester, vol. 72(s1), pages 72-93, September.
  • Handle: RePEc:bla:manchs:v:72:y:2004:i:s1:p:72-93
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    Cited by:

    1. Michael McMahon & Gabriel Sterne & Jamie Thompson, 2005. "The role of ICT in the global investment cycle," Bank of England working papers 257, Bank of England.
    2. Jürgen Antony & Michiel Bijlsma & Adam Elbourne & Marcel Lever & Gijsbert Zwart, 2012. "Financial transaction tax: review and assessment," CPB Discussion Paper 202, CPB Netherlands Bureau for Economic Policy Analysis.
    3. Robert S. Chirinko, 2008. "ó: The Long And Short Of It," CESifo Working Paper Series 2234, CESifo Group Munich.
    4. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(3).
    5. Colin Ellis, 2006. "Elasticities, markups and technical progress: evidence from a state-space approach," Bank of England working papers 300, Bank of England.
    6. Landon, Stuart & Smith, Constance E., 2009. "Investment and the exchange rate: Short run and long run aggregate and sector-level estimates," Journal of International Money and Finance, Elsevier, vol. 28(5), pages 813-835, September.
    7. Simon Price & Christoph Schleicher, 2006. "Returns to equity, investment and Q: evidence from the United Kingdom," Bank of England working papers 310, Bank of England.
    8. Igor Fedotenkov, 2016. "Labour Shares, Fertility and Longevity in an OLG model," Bank of Lithuania Working Paper Series 28, Bank of Lithuania.
    9. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," IMF Working Papers 06/152, International Monetary Fund.
    10. Chirinko, Robert S., 2008. "[sigma]: The long and short of it," Journal of Macroeconomics, Elsevier, vol. 30(2), pages 671-686, June.

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