Working Paper No. 175 | November 1996

What Do Micro Data Reveal about the User Cost Elasticity?

New Evidence on the Responsiveness of Business Capital Formation

The responsiveness of business investment to user costs (interest rates, taxes, and depreciation rates) is important in determining the effect of fiscal policy and aggregate stabilization policy on the economy and for assessing the transmission mechanism of monetary policy to real economic variables. Although this responsiveness is central to the theoretical underpinnings of most economic models, empirical support for substantial responsiveness is lacking. In this working paper, Robert S. Chirinko of Emory University, Research Associate Steven M. Fazzari, of Washington University in St. Louis, and Andrew P. Meyer of the Federal Reserve Bank of St. Louis use micro data to evaluate the user cost elasticity of capital.

The authors employ data obtained from the Compustat database on investment, cash flow, and sales for 4,112 firms for 1981 to 1991. They merge this with industry-level data obtained from Data Resources, Inc., on the user costs of 26 different capital assets variables. Unlike other studies in which user cost variables vary only over time and not across firms, Chirinko, Fazzari, and Meyer's user cost variables vary in both time-series and cross-sectional dimensions. The large number of firm-level observations in the Compustat data increase the precision of the estimates and allow a given parameter to be estimated over a relatively short time frame. The data also help to address questions of biases not easily dealt with when using aggregate time-series data.

Associated Program:
Robert S. Chirinko Steven M. Fazzari Andrew P. Meyer

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