An article in last weeks (October 18-24, 2014) US Print edition of the Economist set off my alarm bells again. It was titled, “Tight, loose, irrelevant”. Interest rates do not seem to affect investment decisions as economist had previously assumed. The article reviews a new paper on the topic that explores the apparent change in relation between interest rates and its relationship to why firms change the level of investment.
History was thought to tell us that a government could stimulate investment and so private sector driven growth by lowering interest rates. Lower rates mean that borrowing money is cheaper so for a given amount of profit, or cash, the opportunity cost falls and so more money is burrowed and invested. If governments want too cool a rapidly growing economy, the opposite was thought true too. Increasing rates mean the burden is larger on firms and so they are dissuaded from investing.
Through the economic crisis and into the current malaise, the world has seen record near-zero interest rates for extended periods of time. Yet private sector investment has not reacted as expected. Why? The report cited by the Economist article suggests that the state and financial performance of the individual firm is a greater signal of its likely desire to increase, or decrease, investment. But even that data is not enough. Corporate profits have been very healthy, and have been up until recently. Presumably interest rates play a role, but it seems far less important a driver or barrier then previously thought. So the issue persists (how do government enthuse growth in private sector investment as a key driver of economic growth) and it seems our understanding of what makes firms tick is still lacking.
As if that was not enough, a related article in the US print edition of the Financial Times, Monday October 20, explored the same issue but from Europe’s position. In Wolfgang Munchau’s Comment piece, Eurozone stagnation is a greater threat than debt, he argues that the chronic shortfall in private sector investment is creating the conditions for a long period of weak demand with falling prices. This would act as a massive anchor on trading nations too, and could be enough to counter any positive effort to promote growth elsewhere in the global economy.
Footnote: It is my firm belief that private sector investment and productivity are two key “handles” that we (collectively) need to tweak if we are to change the current economic situation. The former needs a change in policy at the state level; the latter is firmly in the hands of business leaders. The former also has the opportunity to impact the entire economy at a stroke; the latter has more opportunity at the local, even innovator and individual firm level. And IT plays a key role on the productivity puzzle.
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