Explaining Trends in UK Business Investment

The ratio of business investment to GDP at constant prices has been trending upwards over the past two decades, picking up sharply in the second half of the 1990s. This article investigates possible explanations. We argue that the rise largely reflects a sustained fall in the relative price of investment goods, given that there is little discernible trend in the current-price ratio. This is consistent with a significant role for rapid technological progress in the investment goods sector and, given the importance of imported investment goods, for exchange rate developments in explaining trends in UK firms' investment behavior. But other factors, such as falls in the cost of finance and increases in replacement investment, may also have been important. This view is supported by an illustrative model-based analysis.