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The Response of Business Fixed Investment to Changes in Energy Prices: A Test of Some Hypotheses about the Transmission of Energy Price Shocks

  • Edelstein Paul

    ()

    (Decision Economics, Inc.)

  • Kilian Lutz

    ()

    (University of Michigan and CEPR)

Changes in firms' investment expenditures are considered one of the primary channels through which energy price shocks are transmitted to the economy. It is widely believed that the response of business fixed investment to energy price increases differs from its response to energy price decreases. We show that the apparent symmetry in the estimated responses of business fixed investment in equipment and structures cannot be reconciled with standard theoretical explanations of asymmetric responses. Rather this evidence is an artifact (1) of the aggregation of mining-related expenditures by the oil, natural gas, and coal mining industry and all other expenditures, and (2) of ignoring an exogenous shift in investment caused by the 1986 Tax Reform Act. After controlling for these factors, formal statistical tests are unable to reject the hypothesis of symmetric responses to energy price shocks for all components of investment in structures. For nonresidential equipment there is weak statistical evidence of classical asymmetries in some components, but not in the aggregate. Once symmetry is imposed and mining-related expenditures are excluded, the estimated response of business fixed investment in equipment and structures tends to be small and statistically insignificant. Historical decompositions show that energy price shocks have played a minor role in driving fluctuations in nonresidential fixed investment other than investment in mining.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 7 (2007)
Issue (Month): 1 (November)
Pages: 1-41

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Handle: RePEc:bpj:bejmac:v:7:y:2007:i:1:n:35
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