Elasticities of Business Investment in the U.S. and Their Policy Implications: A Disaggregate Approach to Modeling and Estimation
32 Pages Posted: 15 Jul 2017
Date Written: July 8, 2017
Using data from the U. S. Bureau of Economic Analysis for the period 1947-2015, we estimate investment equations for three types of fixed assets and three policy instruments. In particular, we disaggregate investment into structures, equipment and intangibles, and the policy instruments into the rates of replacement, interest and taxes. Additionally, we estimate an equation for total investment. At the aggregate level the long run elasticities of investment with respect to output and the user cost are found to vary narrowly around 0.83; the direct elasticities of investment with respect to the rates of replacement, interest and taxation are 0.91, -0.04 and -0.23, whereas the indirect and inversely additive ones through the user cost are -0.11, -0.05 and -0.27, respectively. To highlight the significance of these findings, we investigate their implications for economic growth by focusing on four policy channels, i.e. aggregate demand, relative prices, and monetary and fiscal policies. We conclude that monetary policy may be weak to stimulate investment, and even fall into the trap of the law of unintended consequences by slowing replacement investment down, since the average age of capital is related negatively to the discount rate. On the contrary fiscal policy is relatively more potent as a 10% reduction in the expected effective tax rate is found to boost investment directly and indirectly by as much as 5%. In general, first best policies would aim at increasing the replacement rate, particularly of intangibles and equipment in the same order.
Keywords: Business investment, elasticities, economic policies, composition of the capital stock, economic growth
JEL Classification: E22, E52, E62
Suggested Citation: Suggested Citation