The Accelerator Model

 

The accelerator suggests a positive relationship between investment and the growth of demand. Accelerator theories assume that for a business there is a desired capital stock for a given level of output and interest rates. A rise in output or a fall in demand may prompt increased levels of investment as firms adjust to reach the new optimal capital stock level.

 

The accelerator model works on the basis of a fixed capital to output ratio. For example if demand in a given year rises by £4 million and each extra £1 of output requires an average of £3 of capital inputs to produce this output, then the net level of investment required will be £12 million. Consider the diagram below that shows an outward shift of AD that then causes an expansion of production, higher profits and prompts an increase in planned investment at each rate of interest. This boost in demand and output is said to bring about a positive ‘accelerator effect.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One criticism of this simple accelerator model is that the capital stock of a business can rarely be adjusted immediately to its desired level because of ‘adjustment costs’ and ‘time lags’. The adjustment costs include the cost of lost business due to installation of new equipment or the financial cost of re-training workers. A further criticism of the accelerator model is that it ignores the spare capacity that a business might have at their disposal. At the end of a recession, businesses are operating below capacity limits and if demand then picks up in the recovery, they make more intensive use of existing capacity.

 

Reference:  Geoff Riley, 2012, " Capital Investment", http://tutor2u.net/economics/revision-notes/a2-macro-capital-investment.html

It’s the accelerator, stupid! Or is it?

Marco Buti, Philipp Mohl mentioned that the sluggish growth outlook is clearly hampering investment through the traditional accelerator effect (Chirinko 1993). Accelerator models relating investment to GDP usually show a reasonably good fit for the Eurozone (see Figure 1). Of course, the accelerator model should not necessarily be interpreted as showing causality running from GDP growth to investment. But belonging to this model, if we could increase investment correctly, the growth of economy in Europe would be accelerated.

 

Figure 1. Investment regressions using the accelerator model for the Eurozone

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: European Commission.
Note: Estimations based on an EA-12 sample using real gross fixed capital formation to GDP ratios.

 

Reference:

Marco Buti, Philipp Mohl  , "Lacklustre investment in the Eurozone: Is there a puzzle?" Vox, 04 June 2014.