Estimation of the elasticity of substitution between oil and capital

The elasticity of substitution between oil and capital is a key parameter when researchers analyze the effect of oil shocks on the economy by using dynamic general equilibrium models. This paper estimates the elasticity of substitution in the U.S. economy, which is consistent with a large class of DGE models. We find that the estimated elasticity of substitution becomes lower than the value estimated by earlier empirical studies. A low elasticity of substitution implies that oil supply shocks have large impacts on the economy.