This note sheds new light on the dynamic properties of maintenance and repair and examines the behavior of an additional form of capital spending- that of improvements. The analysis examines a unique long-run data set on Swiss road spending.

Andreas Fischer

Michael Dueker

English

Research Papers in Economics

 
 
 
 
 
 
FIXING SWISS POTHOLES 
 
THE IMPORTANCE AND CYCLICAL NATURE OF IMPROVEMENTS 
 
 
Michael J. Dueker 
and 
Andreas M. Fischer 
 
 
 
Working Paper No. 03.01 
 
 
 
 
 
 
 
 
This discussion paper series represents research work-in-progress and is distributed with 
the intention to foster discussion. The views herein solely represent those of the authors. 
No research paper in this series implies agreement by the Study Center Gerzensee and the 
Swiss National Bank, nor does it imply the policy views, nor potential policy of those 
institutions.  
 Fixing Swiss Potholes*
The Importance and Cyclical Nature of Improvements
November 2002
Michael J. Duekerz
and
Andreas M. Fischery
Abstract
This note sheds new light on the dynamic properties of maintenance and
repair and examines the behavior of an additional form of capital spending—
that of improvements. The analysis examines a unique long-run data set on
Swiss road spending.
Keywords: Maintenance and Repair, Improvements, Capital Utilization.
JEL Classiﬁcation Number: E22, E30.
* The authors would like to thank Samuel Reynard and an anonymous referee
for valuable comments.
z Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166, USA.
Telephone: (+1 314) 444 8594
FAX: (+1 314) 444 8731
email: michael.j.dueker@stls.frb.org
y (corresponding Author) Swiss National Bank and CEPR, Postfach, 8022 Zurich,
Switzerland.
Telephone: (+41 1) 631 32 94
FAX: (+41 1) 631 39 05
email: ﬁscher.andreas@snb.ch
11. Introduction
Standard macroeconomic models allow capital to be either employed in
production or idle. Recent studies, however, by McGratten and Schmitz
(1999), Collard and Kollintzas (2000), and Licandro and Puch (2000) con-
sider that capital can also spend time undergoing maintenance and repair.
They ﬁnd empirically that maintenance and repair expenditures are large
and that if this form of spending aﬀects the rate of capital depreciation,
then the dynamic eﬀects of maintenance and repair in model economies are
also large. In particular, such time-varying depreciation rates help model
economies capture important dynamics observed in the U.S. labor market.1
Empirically, private spending on maintenance and repair appears to be
countercyclical, whereas investment in new capital is highly procyclical. Until
now, the empirical evidence that maintenance and repair spending is coun-
tercyclical to GDP is limited to McGratten and Schmitz’s (1999) study using
Canadian data. The rationale for maintenance’s countercyclical behavior is
that it is cheaper for the ﬁrm to repair and maintain machines during periods
1See Ambler and Paquet (1994), Burnside, Eichenbaum and Rebelo (1992, 1996) and
King and Rebelo (2000) for related research.
2of lean demand. One avenue we explore here is to examine the cyclicality of
spending on maintenance of public infrastructure, roads in particular.
In this note, we also consider an additional form of capital spending: out-
lays for improvements, which expand the functions or capabilities of existing
physical capital. Examples include the addition of a lane or rest stops on
an existing highway or the introduction of new ﬁlters in engines to improve
air or water quality. A priori, it is not clear how improvements should be-
have over the business cycle. On one hand, improvements may increase the
productivity of a machine and help expand production during an economic
upswing. On the other hand, improvements, as in the case of maintenance
and repair, require brief periods of shutdown to conduct the upgrades. The
opportunity cost of carrying out improvements might be lower during periods
of economic slowdown. Alternatively in the case of improvements to public
infrastructure, the cyclical trade-oﬀ for governments is that tax revenues are
highly procyclical, encouraging spending on improvements during booms; a
countervailing force is that governments often wish to stimulate the econ-
omy in a countercyclical fashion, in which case discretionary spending on
improvments might be countercyclical.
The objective of this note is two-fold; (i) to document the size of improve-
3ments relative to the other forms of capital spending and (ii) to determine
whether improvements have similar cyclical properties as maintenance and
repair. To shed some light on these issues, we look at a unique data set on
Swiss road spending. The data are broken down into new roads, road im-
provements, and road maintenance and repair (hereafter road maintenance).
The long-run evidence ﬁnds that spending on road improvements is larger in
size than spending on road maintenance and that its cyclical behavior vis-a-
vis GDP varies over time, although both improvements to and maintenance
of this type of public infrastructure are predominantly procyclical.
2. Maintenance, Improvements, and New Roads
The annual data on Swiss road costs are from the Bundesamt f¨ ur Statistik
(BfS) and cover the years from 1927 to 1984.2 Spending on national and can-
tonal roads is divided between road maintenance, road improvement and new
roads. New road investments represent new road and tunnel projects, road
improvements include the building of rest stops, additional highway lanes,
2The publication of this information was discontinued after 1984. The data for im-
provements and maintenance were not published separately before 1927.
4and safety improvements, and maintenance involves mainly road resurfacing.
The road data are constructed by time of expenditure.
Table 1 shows that our measure of road spending averaged 1:6% of GDP
during 1963-1984 compared to 5.8% for education and 2.8% for research and
development for the same period. The addition of local roads, a component
not included in our road measure, would have increased the percentage to
2.2%.
To gain a sense of the size of road improvements relative to other road
outlays, Figure 1 plots spending on road maintenance and road improvement
relative to investment in new roads. The ﬁgure shows that spending on road
improvements is larger than road maintenance for each year except for the
WWII period 1940-47. The average percentage diﬀerence between spending
on road improvement and new roads is 29.0 over the full sample, whereas it
is only 16.1 for road maintenance.
Another feature of Figure 1 is that spending on improvements and main-
tenance relative to new roads shifts over time. During the ﬁrst 30 years of the
sample, road improvements and road maintenance ﬂuctuate considerably and
both are larger than new road investment. In the second half of the sample,
new road investment dominates spending on improvements or maintenance.
5In particular, new road spending increased substantially in the 1960s because
of expensive freeway and tunnel projects.
Next, to examine business cycle movements in real Swiss GDP and real
road spending, we detrend each series by taking logs and subtracting the
trend using the Hodrick-Prescott ﬁlter to obtain our measure of cyclicality.3
Because the long-run series reveal changing dynamics, our remarks are aided
by rolling standard deviations and correlation, which are plotted in Figures
2 to 5. The ﬁrst observation concerning the ﬁltered data regards the low
cyclical volatility of road maintenance. Figure 2 shows the rolling 15-year
standard deviation of GDP and the diﬀerent forms of road spending. Road
maintenance exhibits the lowest cyclical volatility, whereas new road invest-
ment has the highest.
The second observation concerns the procyclical behavior of Swiss road
spending. To examine the cyclicality, we calculated rolling 15-year corre-
lations of the three types of road spending with GDP. In evaluating the
movement in the rolling correlations, it is useful to recall Loretan and En-
3The oﬃcial BfS series for nominal GDP (1948-1984) is linked with the estimated
series from Andrist et al. (2000). Annual CPI is used to deﬂate the nominal variables.
The weight on the squared second diﬀerence of the growth component in the H-P ﬁlter is
set to 100.
6glish’s (2000) caveat that sub-sample and rolling correlations can change
systematically with time-varying conditional volatilities. Suppose that GDP
and a class of road spending have a constant unconditional correlation struc-
ture and covariance matrix, where x is cyclical GDP and y is cyclical road
spending:
x = x + xu;
y = y + yu + (1  
2)
0:5yv; (1)
where u and v have unconditional distributions that are independent stan-
dard normals, although they may have time-varying conditional volatilities
within the sample.
The conditional correlation coeﬃcient between x and y would vary from
its constant unconditional value  within the sample period according to the
conditional volatilities 2
u;t and 2
v;t:
t =
u;t
(22
u;t + (1  2)2
v;t)0:5: (2)
We take the data x and y and sample-wide unconditional values of (x;y;;x;y)
to derive from equation (1) a time series of values of u and v. From these
7vectors, we calculate 15-year rolling estimates of (u;t;v;t) and arrive at an
estimate of t from equation (2). To the extent that the time series t can
match the rolling correlation coeﬃcients, we could attribute the movement
in the rolling correlation coeﬃcient to conditional volatilities temporarily
deviating from their unconditional values.
Figures 3, 4 and 5 depict the rolling 15-year correlations with the values
implied by their rolling conditional volatilities. Figure 3 shows the correla-
tions for road improvements. Road improvements have a correlation coeﬃ-
cient with GDP in the neighborhood of 0.5 for most of the sample, except
between the late 1950s and 1965. In that period, the rolling correlations
become negative, which cannot be explained by a change in relative volatil-
ities and a constant . For most of the sample period, however, the rolling
correlations between road improvements and GDP are well-explained by a
constant underlying correlation structure () and time-varying conditional
volatilities. Road maintenance also experiences negative rolling correlations
with GDP from the late 1950s to 1965. Yet, compared with road improve-
ments, road maintenance has a much less stable cyclical relationship with
GDP. The rolling correlation between road maintenance and GDP depicted
in Figure 4 does not remain at its volatility-implied level after 1965. In-
8stead, the rolling correlation exceeds 0.8 by the mid-1970s and remains high.
We postulate that as the Swiss roadway system became more complex by
the 1970s, planning horizons increased for improvement projects, making
improvement spending less cyclical relative to maintenance spending.
Figure 5 shows that cyclical spending on new roads has the most sta-
ble cyclical relationship with GDP, in that the rolling correlations conform
closely to the volatility-implied levels. Figure 2 shows that the conditional
volatilities of both GDP and new road spending are high at the beginning
of the sample, where the Depression ﬁgures prominently, resulting in a high
volatility-implied correlation that matches the actual rolling correlation. The
volatility-implied correlation is relatively low from the mid-1960s until the
late 1970s, a period when idiosyncratic volatility in new road construction
(v;t) holds down the implied correlation in a way that matches the actual
rolling correlations. Thus, the cyclical correlation between new road spend-
ing and GDP is the most consistent with a constant underlying correlation
structure that is perturbed temporarily by volatility changes. This analysis
indicates that road improvements lie between new road spending and road
maintenance in terms of having a stable cyclical relationship with GDP.
93. Concluding Remarks Regarding Improvements
The long-run data on Swiss road spending allow us to make some compar-
ative statements concerning the ﬁndings of the Canadian survey data docu-
mented in McGratten and Schmitz (1999). First, maintenance expenditures
do not show tremendous cyclical volatility, as found previously in the Cana-
dian government, household and business sector. Nevertheless, the stability
of the cyclical correlation between road maintenance and GDP appears to be
lower than that of improvements and new roads. Second, Swiss spending on
road maintenance and on road improvement as a percentage of spending on
new roads shifts substantially over time. McGratten and Schmitz (1999) ﬁnd
that the ratio of maintenance and repair to new physical capital is trendless
for the post-1960 period. Our long-run data shows that this is only true
for the period considered in McGratten and Schmitz (1999). Prior to 1960,
Swiss spending on road improvement and road maintenance was much larger
in size than new road spending. This latter result strengthens the view of
McGratten and Schmitz (1999) that spending on maintenance and capital
improvements are too large to be ignored in business cycle analysis.
10References
Andrist, F., Anderson, R.G., Williams, M.M., 2000, “Real Output in Switzer-
land: New Estimates for 1914-47,” Federal Reserve Bank of St. Louis
Review, 43-70.
Ambler, S., Paquet, A., 1994, “Stochastic Depreciation and the Business
Cycle,” International Economic Review 35, 101-116.
Burnside, C. A., Eichenbaum, M.S., Rebelo, S.T., 1992, “Labor Hoarding
and the Business Cycle,” Journal of Political Economy 101, 245-273.
Burnside, C.A., Eichenbaum, M.S., Rebelo, S.T., 1996, “Sectoral Solow
Residuals,” European Economic Review 40, 861-869.
Collard, F., Kollintzas, T., 2000, “Maintenance, Utilization, and Deprecia-
tion along the Business Cycle,” CEPR Working Paper No. 2477.
King, R.G., Rebelo, S.T., 2000, “Resuscitating Real Business Cycles,” In:
Taylor, J., Woodford, M. (Eds.), Handbook of Macroeconomics, Vol.
1C. Elsevier.
Licandro, O., Puch, L.A., 2000, “Capital Utilization, Maintenance Costs and
the Business Cycle,” Annales d’Economie et de Statistique 58, 144-164.
Loretan, M. and English, W.B., 2000, Special Feature: Evaluating Changes
in Correlations during Periods of High Market Volatility, BIS Quarterly
Review, June 2000, 29-36.
McGrattan, E.R., Schmitz Jr, J.A., 1999, “Maintenance and Repair: Too
Big to Ignore,” Federal Reserve Bank of Minneapolis Quarterly Review,
2-13.
11Table 1: Type of Activity as a Percentage of GDP (1963-1984)
Public Road Spending (national, cantonal, and local roads) 2.2%
National and Cantonal Road Spending 1.6%
Education 5.8%
Research and Development 2.8%
12-80
-40
0
40
80
120
160
30 35 40 45 50 55 60 65 70 75 80
ln(improv./new roads)*100 ln(maint./new roads)*100
Figure 1: Spending on road improvements and
maintenance relative to new roads (in percent).00
.02
.04
.06
.08
.10
.12
45 50 55 60 65 70 75 80
GDP
IMPROV.
MAINT.
NEW ROADS
Figure 2: Rolling 15-yr. std. devs. of cyclical GDP,
improvements, maintenance and new roads-.8
-.6
-.4
-.2
.0
.2
.4
.6
.8
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 3: Rolling correlations between cyclical GDP and
cyclical road improvements and values implied by
volatility changes alone-0.8
-0.4
0.0
0.4
0.8
1.2
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 4: Rolling correlations between cyclical GDP and
cyclical road maintenance and values implied by
volatility changes alone0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
45 50 55 60 65 70 75 80
ROLLING 15-YR CORR. VOLATILITY-IMPLIED
Figure 5: Rolling correlations between cyclical GDP and
cyclical spending on new roads and values implied by
volatility changes alone

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