Factor Utilization and Adjusted Productivity Estimates for the UK*
| Author | Katharine Neiss,Fergal Shortall,Jens Larsen |
| Date | 01 April 2007 |
| Published date | 01 April 2007 |
| DOI | http://doi.org/10.1111/j.1468-0084.2006.00442.x |
Factor Utilization and Adjusted Productivity
Estimates for the UK*
Jens Larsen,Katharine Neiss and Fergal Shortall
Bank of England, London, UK (e-mail: jens.larsen@bankofengland.co.uk;
katharine.neiss@bankofengland.co.uk; fergal.shortall@bankofengland.co.uk)
Abstract
This paper derives series for capital utilization, labour effort and total factor
productivity (TFP) for the UK from a general equilibrium model with variable
utilization and labour adjustment costs. Capital utilization tracks survey-based
measures closely, but persistent movements in total hours worked mean our labour
effort series is not as highly correlated with its comparators. Our estimated TFP
series is less cyclical than the traditional Solow residual, although a weighted
average of capital utilization and labour effort – aggregate factor utilization – and the
Solow residual are not closely related.
I. Introduction
This article focuses on the importance of factor utilization over the business cycle.
Factor or capacity utilization is a key component of the supply side of the economy,
and is frequently regarded by policymakers as an indicator of the state of real activity.
For example, the Federal Reserve Board’s index of capacity is meant to capture
the concept of the maximum level of output that is sustainable in the short run.
1
*The views expressed in this article are those of the authors and should not be interpreted as those of the
Bank of England or the Monetary Policy Committee. We are grateful to John Muellbauer for providing us
with data on the PUL. We thank a number or anonymous referees, Hasan Bakhshi, Charlie Bean, Ian Bond,
Martin Eichenbaum, Phil Evans, Rain Newton-Smith, Steve Nickell, Evi Pappa, Jonathan Temple and Bank
of England Seminar and Research Away Day participants for extremely useful comments and suggestions.
We would also like to acknowledge prior work by Mark Astley that motivated this article.
JEL Classification numbers: E32, E22, E24, E27.
1
See Gilbert, Morin and Raddock (2000) for a detailed description of the Federal Reserve Board’s index of
capacity, and Roberts (2005) for an example in which capacity utilization is used as a measure of economic
activity in estimating Phillips curves. See also Shapiro (1989) for a discussion of the importance of capacity in
the Federal Open Market Committee’s monetary policy decision making.
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 69, 2 (2007) 0305-9049
doi: 10.1111/j.1468-0084.2006.00442.x
245
ÓBank of England, 2006. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main
Street, Malden, MA 02148, USA.
As a consequence, capacity utilization is often viewed as providing information
regarding the build-up of inflationary pressures. At the meeting of the Bank of
England’s Monetary Policy Committee held on 5–6 June 2001, the Committee
discussed the observation that ‘there was no evidence of inflationary pressures, as
capacity utilization was falling’ (Monetary Policy Committee, 2001, p. 19). And in
the Federal Reserve Board’s Monetary Policy Report to the Congress, submitted on
22 July 1999, it was noted that ‘...[ample capacity]...may help limit inflationary
pressures’ (Federal Reserve Board, 1999, p. 531).
Time-varying factor utilization has also featured heavily in the academic
literature. In addition to other problems associated with measuring productivity often
cited in the literature, such as capital adjustment costs, resource reallocations and
increasing returns to scale, variable factor utilization is thought to account for much
of the variation in the Solow residual and so provides useful insights into
characterizing the business cycle (see Basu and Kimball, 1997; Basu and Fernald,
2001). Recently, interest in models with time-varying factor utilization has increased,
in part due to their relative success in generating persistent output responses to
transitory shocks, both real and nominal (see Cook, 1999; Christiano, Eichenbaum
and Evans, 2005; Neiss and Pappa, 2005).
Given the theoretical as well as policy relevance of factor utilization, this paper
derives empirical measures of capital utilization and labour effort for the UK using a
calibrated model based on Burnside and Eichenbaum (1996) and extended to allow
for labour adjustment costs. These series are then used to improve on conventional
estimates of total factor productivity (TFP). Several interesting results emerge.
First, our estimates of capital utilization for the UK are strongly pro-cyclical and
match survey-based measures of capacity utilization quite closely, providing
supporting evidence that these measures are an accurate reflection of the degree to
which firms are utilizing their existing capital stock. All measures indicate that
capital utilization rose during the first-half of the 1990s, as the capital to output ratio
declined, and then fell back in the second-half of the decade as investment recovered.
Secondly, our model-based labour effort series is much less pro-cyclical. Rather
than being driven by the direct response to exogenous demand or supply shocks, the
profile for effort is dominated by the need to compensate for the more sluggish
evolution of total hours worked. So, for example, we estimate that labour effort fell
during much of the 1990s as total hours rose strongly. Perhaps partly as a result,
and contrary to theoretical predictions, our effort series is only weakly correlated
with both a manufacturing-based measure of labour effort and with average hours
worked.
Nonetheless, our measure of aggregate factor utilization is correlated with
detrended labour productivity. This finding provides some small additional
evidence that the behaviour of heads or hours-based measures of the productivity
of labour over the business cycle may be linked to factor hoarding. In fact, labour
productivity when calculated as output per unit of effective labour input is less
cyclical than a simple output per hour measure.
246 Bulletin
ÓBank of England 2006
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