A Putty-Clay Model of Business Fixed Investment: Technical Paper 2003-09
Working Paper
In this paper, I specify and estimate a model of investment using ex post fixed proportions, or putty-clay capital, for five categories of business fixed investment.
In this paper, I specify and estimate a model of investment using ex post fixed proportions, or putty-clay capital, for five categories of business fixed investment. The specification of expectations causes investment to depend on growth in output less growth in total factor productivity (TFP) and on labor productivity times growth in labor hours at full employment. Thus, demographics can play an important role in investment. TFP at full employment is estimated using a Kalman filter to determine the level that would satisfy an Okun’s Law relationship exactly. Labor and aggregate capital are combined using a Cobb-Douglas production function, but the function aggregating different types of capital allows for elasticities of substitution greater than in a Cobb-Douglas function. The model explains past investment fairly well without the use of constants or lagged dependent variables. The collapse of investment between 2000 and 2003 can be attributed to a slowdown in growth of output relative to growth of productivity, a higher cost of funds caused by lower stock prices, and a slowdown in growth of labor hours at full employment.
