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The empirics of granular origins: some challenges and solutions with an application to the UK

Author

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  • Nikola Dacic

    (Bank of England)

  • Marko Melolinna

    (Bank of England)

Abstract

We study the effects of firm-level microeconomic fluctuations on aggregate productivity in the United Kingdom. We show that a standard measure of residual productivity growth of the largest UK firms (the ‘granular residual’) produces results that are partly counter-intuitive and statistically insignificant. To combat this, we propose a refinement to the widely used control function approach to estimating technology shocks in a production function, which is aimed at accounting for firm-level heterogeneity and the potential existence of common shocks. Using this approach, we find that idiosyncratic firm-level shocks matter for the UK; the ‘granular residual’ can explain around 30% of aggregate UK productivity dynamics. We also show that simplifications of our approach, which do not control for firm-level heterogeneity and the existence of common shocks, do not perform well empirically, highlighting the importance of identifying firm-specific shocks correctly in order to properly test the ‘granularity hypothesis’.

Suggested Citation

  • Nikola Dacic & Marko Melolinna, 2022. "The empirics of granular origins: some challenges and solutions with an application to the UK," Journal of Productivity Analysis, Springer, vol. 58(2), pages 151-170, December.
    • Handle: RePEc:kap:jproda:v:58:y:2022:i:2:d:10.1007_s11123-022-00635-2
    DOI: 10.1007/s11123-022-00635-2
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    References listed on IDEAS

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    More about this item

    Keywords

    Business cycle; Aggregate volatility; Granularity hypothesis; Firm-level productivity;
    All these keywords.

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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