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Modelling investment when relative prices are trending: theory and evidence for the United Kingdom

  • Hasan Bakhshi
  • Nicholas Oulton
  • Jamie Thompson

In recent work, Stacey Tevlin and Karl Whelan argue that aggregate econometric models fail to capture the US investment boom in plant and machinery in the second half of the 1990s, whereas a disaggregated approach does much better. In particular, they show that aggregate models do not capture the increase in replacement investment associated with compositional shifts in the capital stock towards high depreciation rate assets, such as computers. And aggregate models invariably find little or no role for the real user cost, so do not pick up the strong effects of relative price declines on investment in computers. In this paper, a data set for the United Kingdom is constructed in order to investigate the ability of different equations to account for the UK boom in plant and machinery investment in the second half of the 1990s. The findings are similar to those of Tevlin and Whelan, whose analysis is extended in two main ways. First, the failure of the aggregate equations is explained more formally in terms of misspecification when relative prices are trending downwards. Second, the econometric analysis is conducted in a formal cointegration framework. As in the United States, the paper shows that asset-level equations can explain the investment boom in plant and machinery in the second half of the 1990s in the United Kingdom, whereas the aggregate equation fails completely.

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Paper provided by Bank of England in its series Bank of England working papers with number 189.

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Date of creation: May 2003
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Handle: RePEc:boe:boeewp:189
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  1. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 1997. "Long-Run Implications of Investment-Specific Technological Change," American Economic Review, American Economic Association, vol. 87(3), pages 342-62, June.
  2. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  3. Oliner, Stephen & Rudebusch, Glenn & Sichel, Daniel, 1995. "New and Old Models of Business Investment: A Comparison of Forecasting Performance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 806-26, August.
  4. Nicholas Oulton, 2001. "ICT and productivity growth in the United Kingdom," Bank of England working papers 140, Bank of England.
  5. Caballero, Ricardo J, 1994. "Small Sample Bias and Adjustment Costs," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 52-58, February.
  6. Tevlin, Stacey & Whelan, Karl, 2003. " Explaining the Investment Boom of the 1990s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 1-22, February.
  7. Banerjee, Anindya, et al, 1986. "Exploring Equilibrium Relationships in Econometrics through Static Models: Some Monte Carlo Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 253-77, August.
  8. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Hasan Bakhshi & Jens Larsen, 2001. "Investment-specific technological progress in the United Kingdom," Bank of England working papers 129, Bank of England.
  10. Steve Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed & Gertjan Vlieghe, 2004. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," IFS Working Papers W04/12, Institute for Fiscal Studies.
  11. Chow, Gregory C & Lin, An-loh, 1971. "Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 372-75, November.
  12. Saikkonen, Pentti, 1991. "Asymptotically Efficient Estimation of Cointegration Regressions," Econometric Theory, Cambridge University Press, vol. 7(01), pages 1-21, March.
  13. repec:cup:etheor:v:7:y:1991:i:1:p:1-21 is not listed on IDEAS
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