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

Nikola Dacic () and Marko Melolinna ()
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Nikola Dacic: Bank of England
Marko Melolinna: Bank of England

Journal of Productivity Analysis, 2022, vol. 58, issue 2, No 3, 170 pages

Abstract: 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’.

Keywords: Business cycle; Aggregate volatility; Granularity hypothesis; Firm-level productivity (search for similar items in EconPapers)
JEL-codes: E23 E24 E32 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11123-022-00635-2

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