On the Effect of High Energy Prices on Investment

Abstract

Empirical analyses of firm behaviour typically assume that there is a stable relationship between investment on the one hand, and changes in relative prices of inputs, output demand, and other determinants on the other hand. However, because of the lumpy nature of investments and the presence of uncertainty about future economic developments, the percentage change in relative prices and output demand may not lead to the same percentage change in capital stocks. That means that different regimes may exist in investment behaviour. We test whether such regimes exist using data on eight manufacturing industries in the Netherlands. Three different regimes can be identified that are characterised by differences in the relative input price levels, and we find that if relative prices take on extreme values, the propensity to adjust the scale of production to changes in demand is very low.