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 companies (ICC) sector. It complem ents recent work by Cuthbertson and Gasparro, who study an augmented Tobin' s q model of investment in the manufacturing sector. Important focal points of our analysis are a role for real profits (internal funds), which allow firms to combat liquidity constraints when access to capital markets is not perfect, and the impact of irreversibility and uncertainty in determining aggregate investment spending, Earlier work on manufacturing investment by Bean developed a dynamic error-correction specification based on the flexib le accelerator model. Following Cuthbertson and Gasparro we use multivariat e cointegration techniques to discover a parsimonious dynamic model, which can explain the investment experience of the ICC sector in the 1980s and ea rly 1990s. Our results show that a model based on investment and output alo ne does not cointegrate, and a short-run dynamic model of these variables s uffers from heteroscedasticity. This may be consistent with the idea that i ncreased (uncontrolled for) uncertainty has led to increased volatility in investment. The possibility that movements in the real price of gold reflec t uncertainty in financial and other traded commodity markets is explored, Investigation of this more general model indicates that real profits and th e real price of gold can enhance the explanation of investment spending by the ICC sector.