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

64 Pages Posted: 5 Jun 2008

See all articles by Paul Edelstein

Paul Edelstein

Federal Reserve Bank of New York

Lutz Kilian

University of Michigan at Ann Arbor - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: October 2007

Abstract

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 asymmetry 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 assumption 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 mostly 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. Our conclusions are largely robust to defining energy price shocks in terms of percent changes, large percent changes or net percent changes of energy prices; they are also robust to using alternative measures of energy prices and to weighting energy prices by the energy share in value added.

Keywords: 1986 Tax Reform Act, Asymmetric responses, Equipment, Nonresidential fixed investment, Oil price shocks, Structures

JEL Classification: E22, E32, Q43

Suggested Citation

Edelstein, Paul and Kilian, Lutz, The Response of Business Fixed Investment to Changes in Energy Prices: A Test of Some Hypotheses About the Transmission of Energy Price Shocks (October 2007). CEPR Discussion Paper No. DP6507. Available at SSRN: https://ssrn.com/abstract=1140034

Paul Edelstein

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Lutz Kilian (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-2320 (Phone)
734-764-2769 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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