Business investment (red line) has yet to accelerate, even though the Fed's main policy tool, the fed funds rate (blue line) has been pinned at zero since the recession.
New research by Federal Reserve staff economists Steve Sharpe and Gustavo Suarez suggests that the outlook for business investment — a notably lacking aspect of this economic recovery — has little to do with changes in interest rates.
"A fundamental tenet of investment theory and the traditional view of monetary policy transmission is that a rise in interest rates has a sizable negative effect on capital expenditures by businesses," write Sharpe and Suarez in a paper titled The Insensitivity of Investment to Interest Rates: Evidence from a Survey of CFOs.
" Yet, a large body of empirical research offer mixed evidence, at best, for a substantial interest-rate effect on investment."
In the paper, the economists examine data from the quarterly Duke University/CFO Magazine Global Business Outlook survey conducted in September 2012, which asked chief financial officers across companies of various sizes questions related to their spending plans.
The main findings:
The vast majority of CFOs indicate that their investment plans are quite insensitive to potential decreases in their borrowing costs. Only 8% of firms would increase investment if borrowing costs declined 100 basis points, and an additional 8% would respond to a decrease of 100 to 200 basis points.
Strikingly, 68% did not expect any decline in interest rates would induce more investment.
In addition, we find that firms expect to be somewhat more sensitive to an increase in interest rates. Still, only 16% of firms would reduce investment in response to a 100 basis point increase, and another 15% would respond to an increase of 100 to 200 basis points.
In short, most firms wouldn't invest more if long-term interest rates were lower, and the majority wouldn't invest less as long as those rates weren't more than 300 basis points higher.
A sharp rise in long-term rates over the course of 2013 allowed Sharpe and Suarez to validate these results with follow-up questions asked in the same survey a year later:
By August 2013, twelve months after Global Business Outlook surveyed firms on their sensitivity to hypothetical interest rate changes, long-term interest rates had in fact risen substantially; notably, yields on 10-year Treasury bonds and investment-grade bonds were about 100 basis points higher. Fortuitously, the Global Business Outlook survey for the third quarter of 2013 once again included questions about interest-rate sensitivity, including a retrospective question:
"Over the past quarter, interest rates have increased by 1%. What effect have higher rates had to this point on your capital spending [also hiring, debt financing]?"
Among the 396 usable responses to this question, 9 CFOs indicated their capital spending was “reduced significantly” and 28 indicated it was “reduced somewhat”. Thus, in total, 9.3% of respondents claimed they had reduced capital spending in response, closely in line with the 10% of respondents from the 2012 survey who predicted their firm would reduce investment plans in response to a 100 basis point increase.
The August 2013 survey also included this question: " If benchmark long-term interest rates increase 1% [more] by the end of 2013, will this affect your capital spending?"
"For the 91% of the sample respondents that had not indicated reducing capital spending as a result of the recent 1% increase in interest rates, their responses to the forward- looking question in principle should indicate whether a total increase in interest rates (by year end) of 2% would induce a cutback in their capital spending," write the Fed economists. "Within this group, only 15 respondents, about 3.7% of the overall sample, indicated they would likely reduce capital spending as a result. This suggests even less sensitivity to a 200 basis point increase than the results from the original survey."
So what does determine business investment?
The Global Business Outlook survey also asks CFOs for the top three company-specific concerns they face.
" The responses a firm chooses to this question might be indicative of characteristics that are likely to influence firm investment plans," write Sharpe and Suarez. "The two most commonly chosen of the standard response choices offered are concern with 'ability to maintain margins' and 'cost of health care,' flagged by about 60% and 40% of sample respondents, respectively."
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