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Aggregate returns to scale: why measurement is imprecise

  • Harold L. Cole
  • Lee E. Ohanian

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

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Article provided by Federal Reserve Bank of Minneapolis in its journal Quarterly Review.

Volume (Year): (1999)
Issue (Month): Sum ()
Pages: 19-28

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Handle: RePEc:fip:fedmqr:y:1999:i:sum:p:19-28:n:v.23no.3
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  1. Susanto Basu, 1995. "Procyclical Productivity: Increasing Returns or Cyclical Utilization?," NBER Working Papers 5336, National Bureau of Economic Research, Inc.
  2. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  3. Ellen R. McGrattan, 1994. "A progress report on business cycle models," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 2-16.
  4. Benhabib, Jess & Farmer, Roger E.A., 1991. "Indeterminacy and Increasing Returns," Working Papers 91-59, C.V. Starr Center for Applied Economics, New York University.
  5. Kamihigashi, Takashi, 1996. "Real business cycles and sunspot fluctuations are observationally equivalent," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 105-117, February.
  6. 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.
  7. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1995. "Capital Utilization and Returns to Scale," CEPR Discussion Papers 1221, C.E.P.R. Discussion Papers.
  8. Marianne Baxter & Robert G. King, 1991. "Productive externalities and business cycles," Discussion Paper / Institute for Empirical Macroeconomics 53, Federal Reserve Bank of Minneapolis.
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