A Theory of Vintage Capital Investment and Energy Use

Abstract

In this paper we propose a theory of investment and energy use to study the response of macroeconomic aggregates to energy price shocks. In our theory this response depends on the interaction between the energy efficiency built in capital goods (which is irreversible throughout their lifetime) and the growth rate of Investment Specific Technological Change (ISTC hereafter). ISTC reduces the cost to produce investment goods and renders them more productive. Depending on which effect is stronger, higher ISTC is a complement or a substitute for energy efficiency and, thus, affects differently aggregate energy demand. Our theory provides a discipline to identify both effects since it predicts that the relative price of investment goods (not quality adjusted as well as quality adjusted) depends not only on the two ISTC shocks but also on the energy efficiency built into capital units. Thus, we can disentangle the effects of ISTC shocks from the effects of energy efficiency: a distinction that the literature on ISTC growth abstracts from. Our theory can account for the fall of energy use per unit of output observed during the 1990s, a period in which energy prices fell below trend. By increasing investment in the years of high ISTC growth, the economy was increasing the average efficiency of the economy (the capital-energy ratio), shielding the economy against the impact of the 2003-08 price shock.