1. Ellen R. McGrattan and Edward C. Prescott
The T.S. Kim Memorial Seminar, September 14, Unmeasured Investment and the U.S. 1990s Hours Boom
Ellen R. McGrattan and Edward C. Prescott
Arizona State University and
Federal Reserve Bank of Minneapolis

2. The U.S. 1990s Boom
It is puzzling from the perspective of the standard growth model
Because …

3. 1990s Hours Boom
Hours boomed
but labor
productivity
did not.

4. Resolution of Puzzle: Unmeasured Investment
Standard measurement and theory mask real economic story
Economic output includes a lot of unmeasured investment
Tech boom led to
Very large increase in unmeasured investment
Large increase in market hours
Large increase in economic output
Sizable increase in economic output per hour

5. Outline Show 1990s is puzzling for standard model
Extend model to include intangible, which is not measured, capital investment
Permit nonneutral technological change with respect to producing intangible capital and measured output
Show there is no puzzle when the 1990s is viewed through the lens of this extended model

6. Show 1990s a puzzle for standard theory

7. Theory without Unmeasured Investment
Stand-in household maximizes

8. Stand-in firm's technology
Use BEA & CPS data to determine TFP path
Compute perfect foresight equilibrium path given TFPs, tax rates, and populations

9. Predicted and Actual Per-Capita Hours
Large deviation
from theory!
TFP increase
small and taxes
rose.

10. Something Important Is Missing … Our conjecture is unmeasured investment Observations leading to this conjecture

11. Profits Fell in the Boom
Would predict
high profits
in the boom.

12. R&D and High Tech Sector Boomed
Private business R&D increased much more than GDP in the 1990s
Many new high tech firms – e.g., in Silicon Valley

13. Growth Model with Unmeasured Investment
Household/business owners solve
where subscript m/u denotes measured/unmeasured and q is a price

14. Technologies Technology 1 – producing goods and services
Technology 2 – producing intangible capital
Total stock of intangible used by producers and researchers

15. Two Types of Intangible Investment
Expensed: capital owners finance with reduced profits
Sweat: worker owners finance with uncompensated time
Parameter has tax implications

16. Before Using the Extended Model Must Revise Data in Light of Theory

17. Starting Point: National Accounts
NIPA INCOME
NIPA PRODUCT
Capital consumption
Personal consumption
Taxes on production
Government consumption
Compensation less sweat
Government investment
Profits less expensed
Private tangible investment
Net interest
Net exports

18. Revised National Accounts
TOTAL INCOME
TOTAL PRODUCT
Capital consumption
Personal consumption
Taxes on production
Government consumption
Compensation less sweat
Government investment
Profits less expensed
Private tangible investment
Net interest
Net exports
Capital gains
Intangible investment

19. Revised National Accounts
TOTAL INCOME
TOTAL PRODUCT
Capital consumption
Personal consumption
Taxes on production
Government consumption
Compensation
Government investment
Profits
Private tangible investment
Net interest
Net exports
Intangible investment

20. Two Additional Steps Construct sub accounts and hours for:
Business: corporate and noncorporate
Nonbusiness: households, government, nonprofits
because business sector is relevant for our model
Use BEA and CPS data to set parameters

21. Using the Model Find TFPs from observables
Must use equilibrium conditions given unmeasured investment not observed
As for previous analysis, do not use intertemporal marginal condition for tangible capital
Compute perfect foresight equilibrium path given TFPs

22. Start with Sequences of TFPs
With period t observations on NIPA products, total hours, tax rates
Intratemporal marginal condition → sector hours
Sector rental rates equated → sector tangible capital stocks
Sector wage rates equated → intangible investment output
Current observation and equilibrium conditions imply all inputs and outputs to the two production functions
Except for intangible capital

23. Finding the path of intangible Capital Stock
Begin with a steady state value for 1990
Intertemporal condition →
Boundary condition is

24. Start out with 1990 tangible capital stock and 1990 implied intangible capital stock
Given population, tax rates, and implied TFPs, computed perfect foresight equilibrium path
Intertemporal marginal conditions for tangible capital investment never used as case in the standard model analysis
Path could go way off

25. Implied Sectoral TFPs Which are very different from standard
TFP measure
estimated for
US.

26. Observations in Close Conformity with Theory

27. Predicted and Actual Hours
Predicts
large increase
in hours:
consistent
with US.

28. Predicted and Actual Business Labor Productivities
Predicts
below trend
and then
above at end
of 1990s:
consistent
with US.

29. Predicted and Actual Tangible Investment
Only a modest
deviation
in tangible
investment.

30. Comparing Theory and NIPA Wages
Income account statistics not used in determining implicit TFPs and intangible capital stocks
Consequently this is a demanding test

31. Question Does model yield accurate predictions for NIPA compensation?
To answer,
Put a BEA accountant in model economy
Accountant estimates household’s compensation as:

32. Predicted and Actual Business Compensation
Theory and
data match up
surprisingly
well!

33. Implications for Capital Gains
We put Flow of Funds accountant in model
Accountant computes capital gains on businesses
This is another demanding and independent test

34. Compare FOF Gains to Change in Business Value
Business value in t:
which depends on value of intangible stock

35. U.S. Non-Real Estate Capital Gains
Above-trend
gains in late
1990s as
implied by
theory.

36. The 1990s in Light of Theory with Unmeasured Investment

37. Model: Total and Measured Output
Large
differences
between
accounting
and economic
measures due
to intangible
investment.

38. Net Intangible Investment Share of Total Output
Bottom line:
Intangible
Investment
was large in
the 1990s!
Too Big to
Ignore!

39. Model: Total and Measured Business Labor Productivity
Large
differences
between
accounting
and economic
measures due
to intangible
investment.

40. Conclusions And, the 1990s boom
The growth model with unmeasured investment accounts for a variety of macro observations
Growth
Business cycle phenomena
Depressions
Stock market
And, the 1990s boom