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Nonresidential vs. Residential Investment

by: Menzie Chinn posted on: June 17, 2008

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Nonresidential investment has been increasing until 2008Q1, at which time it essentially stalled (-0.2 ppts. annualized in log terms). On the basis of past historical correlations, what's in store?

Figure 1: Four quarter growth rate in nonresidential investment (blue) and residential investment (red) lagged one year, calculated as four quarter log difference. Source: BEA GDP release of 29 May 2008, NBER, and author's calculations.

Figure 1 depicts the time series for year-on-year nonresidential investment growth, and residential investment growth lagged four quarters. There's an obvious correlation, but clearly it's not a particularly strong one. There are periods where business fixed investment levitates above residential growth, such as the latter part of the 1980s (due to the dollar's depreciation), and during the 1990s, as well as the most recent few quarters. The relationship can be summarized using a OLS regression of 4-quarter growth on 4-quarter growth rates.

d(nresinv)_t = 0.035 + 0.311 d(resinv)_t-1 + u_t

Adj. R² 0.37, SER = 0.054, smpl 1967q1-08q1, bold face denotes statistical significance at 1% MSL.

Using quarter-on-quarter growth rates yields a similar result (i.e., the cumulative coefficients on four lags of changes in residential investment sum to 0.33, as opposed to the 0.311 coefficient above).

What does this predict for year-on-year business fixed investment growth in 2009Q1? That's shown in Figure 2.

Figure 2: Four quarter growth rate in nonresidential investment (vertical axis) plotted against four quarter growth rate in residential investment lagged one year (horizontal axis), regression line (purple), and forecast for 2009Q1 based on 2008Q1 data (red square). Source: BEA GDP release of 29 May 2008, and author's calculations.

The regression indicates a 3.8% 4 quarter decline (in log terms) in 2009q1. It's unclear to me how this fits in with other forecasts. The q4/q4 prediction I obtain of -2.9% is somewhat less than the 0.3% (non-log terms) decline forecasted by the participants of the Chicago Fed Automotive Outlook symposium [1].

An alternative approach would be to try to explain investment using variables that theory says might be important. As discussed in this post on the investment disconnect, corporate profits is one candidate. In Figure 3, I plot 4 quarter changes in nonresidential investment and in real corporate profits.

Figure 3: Four quarter growth rate in nonresidential investment (blue) and in real corporate profits (red) lagged one year, calculated as four quarter log difference. Real corporate profits calculated by deflating by GDP deflator. Source: BEA GDP release of 29 May 2008, BEA via FRED II, NBER, and author's calculations.

This relationship,

d(nresinv)_t = 0.034 + 0.317 d(cprofits)_t-1 + u_t

Adj. R² 0.29, SER = 0.058, smpl 1967q1-08q1, bold face denotes statistical significance at 1% MSL.

predicts that the 4 quarter change in nonresidential investment will be about 0.3 ppts. in 2009q1.

In either case -- using a lead-lag relationship [2], or one based upon a version of a cash-flow model -- investment growth will be slowing down over the next year.

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