Academic journal article Quarterly Journal of Austrian Economics

Cyclical Capital Stock1

Academic journal article Quarterly Journal of Austrian Economics

Cyclical Capital Stock1

Article excerpt

ABSTRACT: It is common to assume in business cycle analysis that the capital stock is homogenous and constant in aggregate value. We explore the alternative concept that capital is heterogeneous, and whether it exhibits cyclical changes. A multiperiod model of investment implies that acquisition of specific components of capital responds to changes in relative interest rates, and we further show that the structure of rates is cyclical. If cyclical changes in the composition of capital are substantial, that is another mechanism to propagate the business cycle. Detailed data of specific capital types are available for U.S. passenger airlines, a cyclical industry. We find that there are regular patterns by which airlines adjust the mix of capital. Results suggest a capacity constraint influence in determining movements of aggregate income.

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INTRODUCTION

The assumption of a fixed capital stock for short-run macroeconomic analysis is common and considered reasonable. While simplifying assumptions facilitate development of hypotheses, they can also hinder or distort the explanation of behavior. Ag- gregate investment expenditure by firms is cyclical and volatile, and those characteristics have long been central to explanations of business cycle movements in output. In cyclical analysis, investment flows are assumed to be of small enough magnitude that neither the total value of capital nor its composition affects aggregate economic activity. Whether the composition of capital stock varies systematically, and by how much, are empirical questions, and should be considered before assuming capital stock to be fixed. If the composition varies cyclically, we should understand why, and what that may contribute to the explanation of the variation of aggregate income through a business cycle.

By comparison, our understanding of the aggregate labor market improved with the analysis of Davis, Haltiwanger and Schuh (1997) and subsequent research. They found several "basic facts" about how aggregate employment changes over a business cycle and also in the long run, such as: flows of job creation and job destruction are large, job destruction is more cyclically volatile than job creation, and that changes in job aggregates are persistent. We consider these same issues for capital markets. Behind the growth of total capital over time are flows of increases and decreases in the components of the stock. Capital is created by investment, and destroyed by depreciation, technical obsolescence, change in demand for the product or service, regulation and other factors. Are these flows cyclical, persistent and substantial in magnitude, or may we continue with a reasonable assumption that capital is fixed?

This paper provides a framework for the question of whether a heterogeneous capital stock can influence cyclical changes in aggregate income. First we present a multiperiod model of investment in which decisions are made about more than one type of capital good. These decisions have long reaching consequences for the amount and type of capital used in an industry. We show that investment flows for different components of capital are differentially influenced by changes in interest rates. If interest rates exhibit cyclical behavior, the relative price influence results in cyclical movements in components of capital stock through investment flows and the later conversion of capital types. Finally, we explore capital stock composition and how it relates to cyclical changes in real GDP using the example of a cyclical industry, U.S. passenger airlines.

MOTIVATION AND PREVIOUS RESEARCH

In addition to its role in aggregate demand, investment alters the magnitude of capital stock over time, and aggregate supply. Relative factor proportions of capital and labor are a vital mechanism in Real Business Cycle and Austrian models of cycles. Typically through random shocks or trends, changes in capital stock affect the capacity limitations on aggregate supply. …

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