The Empirics of Granular Origins: Some Challenges and Solutions with An Application to the UK

30 Pages Posted: 24 Dec 2019

Date Written: December 20, 2019

Abstract

We study the effects of firm-level microeconomic fluctuations on aggregate productivity in the United Kingdom. We show that a standard measure of residual productivity growth of the largest UK firms (the ‘granular residual’) produces results that are counter-intuitive and not statistically significant. To combat this, we introduce a unique production function approach to estimate firm-specific technology shocks, accounting for firm-level heterogeneity and common shocks. Using this measure, we find that firm-level shocks matter; the ‘granular residual’ explains around 30% of aggregate UK productivity dynamics. We also show that simplifications of our approach, which omit controlling for firm-level heterogeneity or do not account for common shocks, do not perform well, highlighting the importance of identifying firm-specific shocks correctly in order to properly test the ‘granularity hypothesis’.

Keywords: business cycle, aggregate volatility, granularity hypothesis, firm-level productivity

JEL Classification: E23, E24, E32

Suggested Citation

Dacic, Nikola and Melolinna, Marko, The Empirics of Granular Origins: Some Challenges and Solutions with An Application to the UK (December 20, 2019). Bank of England Working Paper No. 842, December 2019, Available at SSRN: https://ssrn.com/abstract=3508666 or http://dx.doi.org/10.2139/ssrn.3508666

Nikola Dacic

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Marko Melolinna (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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