Business Investment, Cost of Capital and Uncertainty in the United Kingdom — Evidence from Firm-Level Analysis

38 Pages Posted: 8 Mar 2018

See all articles by Marko Melolinna

Marko Melolinna

Bank of Finland - Monetary Policy

Helen Miller

Institute for Fiscal Studies (IFS)

Srdan Tatomir

Bank of England

Date Written: March 2, 2018

Abstract

We use new firm-level estimates of the cost of capital and uncertainty to study the drivers of UK business investment in a neoclassical investment model. We construct firm-specific measures of the cost of capital and uncertainty and use new UK survey data to estimate firm-specific investment hurdle rates. There is substantial variation in the cost of capital and uncertainty faced by firms and we find both matter for investment. Firm heterogeneity might help explain the difference in firms’ investment paths shortly after the Great Recession. This suggests that, while common shocks, that is, aggregate uncertainty matters, it is also important to capture firm-specific uncertainty to better explain investment dynamics. Overall, between 2000 and 2015 investment responded relatively sluggishly to the cost of capital and more sharply to uncertainty, especially after the financial crisis. There are implications for monetary and macroeconomic policy. The relative importance of measures that alleviate uncertainty compared to changes in monetary policy rates could be larger than generally recognised.

Keywords: Investment, micro data, panel regression, hurdle rates, cost of capital, uncertainty

JEL Classification: C23, D22, E22, E44

Suggested Citation

Melolinna, Marko and Miller, Helen and Tatomir, Srdan, Business Investment, Cost of Capital and Uncertainty in the United Kingdom — Evidence from Firm-Level Analysis (March 2, 2018). Bank of England Working Paper No. 717, Available at SSRN: https://ssrn.com/abstract=3135917 or http://dx.doi.org/10.2139/ssrn.3135917

Marko Melolinna (Contact Author)

Bank of Finland - Monetary Policy ( email )

PO Box 160
00101 Helsinki
Finland

Helen Miller

Institute for Fiscal Studies (IFS) ( email )

7 Ridgmount Street
London, WC1E 7AE
United Kingdom

Srdan Tatomir

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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