Getting normalization right: Dealing with ‘dimensional constants’ in macroeconomics

Cristiano Cantore and Paul Levine ()

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 12, 1931-1949

Abstract: We contribute to a recent literature on the normalization, calibration and estimation of CES production functions. The problem arises because CES ‘share’ parameters are not in fact shares, but depend on underlying dimensions—in other words they are ‘dimensional constants’. It follows that such parameters can neither be calibrated nor be estimated unless the choice of units is made explicit. We use an RBC model to demonstrate two equivalent solutions. The standard one expresses the production function in deviation form about some reference point, usually the steady state of the model. Our alternative, ‘re-parameterization’, expresses dimensional constants in terms of a new dimensionless (share) parameter and all remaining dimensionless ones. We show that our ‘re-parameterization’ method is equivalent and arguably more straightforward than the standard normalization in deviation form. We then examine a similar problem of dimensional constants for CES utility functions in a two-sector model and in a small open economy model; then re-parameterization is the only solution to the problem, showing that our approach is in fact more general.

Keywords: CES production function; Normalization; CES utility function (search for similar items in EconPapers)
JEL-codes: E23 E32 E37 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (43)

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Related works:
Working Paper: Getting Normalization Right: Dealing with ‘Dimensional Constants’ in Macroeconomics (2011)
Working Paper: Getting Normalization Right: Dealing with 'Dimensional Constants' in Macroeconomics (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:12:p:1931-1949

DOI: 10.1016/j.jedc.2012.05.009

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