Working Paper no. 162
By Jens Larsen, Katharine Neiss and Fergal Shortall
This paper derives series for capital utilisation, labour effort and total factor productivity (TFP) from a general equilibrium model with variable factor utilisation and labour adjustment costs. Impulse responses from the model show that firms initially respond to unanticipated shocks by altering factor utilisation rates. In subsequent periods, firms adjust observable inputs such as physical capital and employment. As a result, utilisation rates are a leading indicator of firms’ hiring of both capital and labour. We find that our estimate of capital utilisation tracks survey-based measures quite closely, while movements in total hours worked drive our labour effort series. Our estimate of TFP growth is found to be less cyclical than the rate of growth of a traditional Solow residual. Nevertheless, a weighted average of capital utilisation and labour effort – aggregate factor utilisation – is not closely related to the detrended Solow residual. This suggests that measures that conflate capacity utilisation and temporary deviations in TFP from its steady-state growth rate may be misleading indicators of excess demand pressure. Rather, our measure of aggregate factor utilisation is correlated with detrended labour productivity, providing more evidence that differences in average and marginal labour productivity may be linked to factor hoarding. Labour productivity, when calculated as output per unit of effective labour input, is less cyclical than a simple measure of output per hour.