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Aggregate returns to scale: why measurement is imprecise

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  • Harold L. Cole
  • Lee E. Ohanian

Abstract

The extent to which there are aggregate returns to scale at the level of aggregate production has important implications both for the types of shocks generating business cycles and for optimal policy. However, prior attempts to measure the extent of these returns using instrumental variable techniques have yielded quite imprecise estimates. In this article, we show that the production shocks implied by a range of returns to scale that encompasses both large increasing returns and large decreasing returns are almost identical. This makes clear that there is a fundamental reason for the imprecision of prior estimates and casts doubt on our ability to generate more precise estimates

Suggested Citation

  • Harold L. Cole & Lee E. Ohanian, 1999. "Aggregate returns to scale: why measurement is imprecise," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 19-28.
  • Handle: RePEc:fip:fedmqr:y:1999:i:sum:p:19-28:n:v.23no.3
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    References listed on IDEAS

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    1. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 745-775, August.
    2. Aoki, Masanao & Fiorito, Riccardo, 1993. "Analysis of US real GNP and unemployment interactions : State space approach," Journal of Economic Dynamics and Control, Elsevier, pages 385-399.
    3. Kamihigashi, Takashi, 1996. "Real business cycles and sunspot fluctuations are observationally equivalent," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 105-117, February.
    4. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1995. "Capital Utilization and Returns to Scale," NBER Chapters,in: NBER Macroeconomics Annual 1995, Volume 10, pages 67-124 National Bureau of Economic Research, Inc.
    5. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, pages 11-44.
    6. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
    7. Harold L. Cole & Lee E. Ohanian, 1996. "Reassessing aggregate returns to scale with standard theory and measurement," Working Papers 566, Federal Reserve Bank of Minneapolis.
    8. Ellen R. McGrattan, 1994. "A progress report on business cycle models," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 2-16.
    9. Marianne Baxter & Robert G. King, 1991. "Productive externalities and business cycles," Discussion Paper / Institute for Empirical Macroeconomics 53, Federal Reserve Bank of Minneapolis.
    10. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, pages 11-44.
    11. Susanto Basu, 1996. "Procyclical Productivity: Increasing Returns or Cyclical Utilization?," The Quarterly Journal of Economics, Oxford University Press, vol. 111(3), pages 719-751.
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    Citations

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    Cited by:

    1. Andreas Beyer & Roger E. A. Farmer, 2004. "On the Indeterminacy of New-Keynesian Economics," Computing in Economics and Finance 2004 152, Society for Computational Economics.
    2. Mark Weder, 2006. "A heliocentric journey into Germany's Great Depression," Oxford Economic Papers, Oxford University Press, vol. 58(2), pages 288-316, April.
    3. Mark Weder, 2004. "Taylor Rules: intercepting expectations," Money Macro and Finance (MMF) Research Group Conference 2003 110, Money Macro and Finance Research Group.
    4. Weder, Mark, 2004. "Near-rational expectations in animal spirits models of aggregate fluctuations," Economic Modelling, Elsevier, vol. 21(2), pages 249-265, March.
    5. Fève, Patrick, 2004. "Indeterminacy Produces Determinacy," IDEI Working Papers 333, Institut d'Économie Industrielle (IDEI), Toulouse.
    6. Guo, Jang-Ting & Lansing, Kevin J., 2002. "Fiscal Policy, Increasing Returns, And Endogenous Fluctuations," Macroeconomic Dynamics, Cambridge University Press, vol. 6(05), pages 633-664, November.
    7. Nadenichek, Jon, 2007. "Consumer confidence and economic stagnation in Japan," Japan and the World Economy, Elsevier, vol. 19(3), pages 338-346, August.
    8. Beyer, Andreas & Farmer, Roger E. A., 2003. "On the indeterminacy of determinacy and indeterminacy," Working Paper Series 277, European Central Bank.
    9. Harrison, Sharon G. & Weder, Mark, 2006. "Did sunspot forces cause the Great Depression?," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1327-1339, October.
    10. Weder, Mark, 2003. "Taylor Rules in Practice: How Central Banks can Intercept Sunspot Expectations," CEPR Discussion Papers 3899, C.E.P.R. Discussion Papers.

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    Keywords

    Business cycles;

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