Econometric Modelling of UK Aggregate Investment: The Role of Profits and Uncertainty

This paper focuses on the determinants of aggregate investment spending in the UK, for the industrial and commercial company (ICC) sector. Important focal points of our analysis are the role for real profits and the impact of irreversibility and uncertainty in determining aggregate investment spending. Early work on manufacturing investment by Bean (1981a) developed a data-based dynamic specification of considerable complexity. We use multivariate cointegration techniques to discover a parsimonious dynamic model, which can explain the 1980s and early 1990s investment experience of the ICC sector. Our results show that a model based on investment and output alone does not cointegrate, and a short run dynamic model of these variables suffers from heteroscedasticity. This may be consistent with the idea that increased (uncontrolled for) uncertainty has led to increased volatility in investment. Investigation of a more general model indicates that real profits can enhance the explanation of investment spending, and that a potential proxy for uncertainty is the real price of gold.