Estimating the Euler Equation for Aggregate Investment with Endogenous Capital Depreciation

Abstract

This article looks at the empirical consequences of introducing endogenous capital depreciation in the standard neoclassical model with quadratic adjustment costs. To this end, we formulate an empirical specification that accommodates capital maintenance and utilization in the Euler equations for aggregate investment. The empirical estimates with data from the Canadian Survey on Capital and Repair Expenditures show that, in contrast to the existing literature, the performance of the Euler equations is improved when we account for the impact of variable capital depreciation.

Growth with Unused Capacity and Endogenous Capital Depreciation

“…The hypothesis of an endogenous rate of depreciation has been introduced into several mainstream models. See, for example, Nickell (), Schmalensee (), Nelson and Caputo (), Moretto (), Licandro and Puch () and Angelopoulou and Kalyvitis (). See also Steedman (), who considers different rates of depreciation in a two‐sector model.…”

“…The problem of maintenance is more relevant in mainstream analyses of depreciation, as they are essentially concerned with the problem of the firms’ optimal choice between new investment and lengthening the duration of their existing capital stock. See, for example, Schmalensee (), Nickell (), Moretto () and Angelopoulou and Kalyvitis ().…”

“…See alsoSchoder (2014) for empirical evidence of the endogeneity of capacity utilization.14 Kurz (1990) mentions the possibility that different degrees of capacity utilization may imply different rates of depreciation, but he does not offer a detailed analysis of such possibility.15 The hypothesis of an endogenous rate of depreciation has been introduced into several mainstream models. See, for example,Nickell (1978),Schmalensee (1974),Nelson and Caputo (1997),Moretto (1999),Licandro and Puch (2000) andAngelopoulou and Kalyvitis (2012). See alsoSteedman (2006), who considers different rates of depreciation in a two-sector model.…”

Growth with Unused Capacity and Endogenous Depreciation

“…14 The problem of maintenance is more relevant in mainstream analyses of depreciation, as they are essentially concerned with the problem of the firms' optimal choice between new investment and lengthening the duration of their existing capital stock. See, e.g., Schmalensee (1974), Nickell (1978) and Angelopoulou and Kalyvitis (2012).…”

“…12 When deviates from , also 11 The hypothesis of an endogenous rate of depreciation has been introduced into several mainstream models. See, for example, Nickell (1978), Schmalensee (1974), Nelson and Caputo (1997), Licandro and Puch (2000) and Angelopoulou and Kalyvitis (2012). 12 When capacity is not at its normal degree of utilization, production takes place at a ratio of capital to labor deviates from : it increases (decreases) when the actual degree of capacity utilization is above (below) its normal level.…”