Thursday, April 16, 2015

3:07 AM

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Investment Unfazed by Interest Rates
Jerold Warner

Contrary to claims by the Fed,
in-depth analysis shows little
correlation between low interest
rates and corporate investment.
How is corporate investment affected when changes in profits, stock returns, market uncertainty, and interest rates come into play?

In “The Behavior of Aggregate Corporate Investment,” Simon professor Jerold Warner, with coauthors S.P. Kothari, of Massachusetts Institute of Technology and Jonathan Lewellen ’97S (MS), ’00S (PhD) of Tuck School of Business at Dartmouth College, studied aggregate corporate investment by US firms from 1952 to 2010. Using quarterly information, they looked at the total amount of capital investment by all firms with public data. Their results challenge conventional wisdom and established theoretical models.

They found, not surprisingly, that investment grows rapidly following high profits and stock returns. Contrary to standard predictions, however, investment growth has little to do with recent changes in market volatility or interest rates.

In addition, when aggregate corporate investment goes up, future profits and market returns go down. This connection is so strong, in fact, that “it almost fully reverses the profit growth leading up to investment,” they write.

Warner and his coauthors also found little evidence that unusual conditions in credit markets lead to a large drop in investment over and above what would be expected given changes in the real economy. The standard story is that if the cost of capital goes up, investment should fall. But they found no evidence that investment growth slows after a rise in short- and long-term interest rates.

This lack of a link between aggregate investment and interest rates is particularly interesting, Warner says—and it shines a light on important macroeconomic and policy implications.

“This is not consistent with the story from the Fed, which is that if we reduce interest rates we’ll get more investment,” he says. “Reducing interest rates doesn’t seem to affect corporate capital investment. That’s something that people have found to be very interesting about our study. It certainly isn’t consistent with any claims the Fed might make about its ability to affect corporate investment.”

—Sally Parker


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