Panel cointegration estimates of the user cost elasticity

The effect of user cost on the capital stock is an issue of central importance in economics, with implications for tax policy, economic development, growth, monetary policy, business cycle models, and other areas. Estimating the user cost elasticity raises serious simultaneity problems because of the large fluctuations in investment demand at business cycle frequencies. If shifts in the supply curve (due to technological change and tax reforms) are more persistent than shifts in demand, cointegration techniques, which emphasize long-run movements, can reduce the simultaneity problem. If shocks to capital demand are partially idiosyncratic, the use of firm-level panel data should also reduce the simultaneity problem. In this paper, we therefore use cointegration techniques to estimate the user cost elasticity on panel data. Specifically, we employ a newly constructed data set with a long time series of firm-level data on the capital stock and with detailed industry-specific data on the interest rate, the price of investment goods, risk, and taxes.