One issue people continually fail to grasp is that low rates are setting a low bar for capital investment. The result is shitty assets/investments/businesses.[1] People will only jump as high as the bar requires.
Think of the analogy of your Kid: Would you set the bar low and expect the kid to excel and get into Stanford? No. Thats now how it works. Without coaching, encouragement, benchmarking, and measurement, success is the exception not the rule.
Why is this so hard for DC to grasp? The empirical datapoint on this is clearly Japan in the 1990's. Ultra-low interest rates, and ultra-cheap capital might spur investment, but not <profitable> investment. Twice as much investment at 1/2 of the return on capital is not moving you anywhere.
That's a major part of the problem. USA have been facing this since the Greenspan stimulus following the Dot-Com crash in the early 00's.
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[1] This might work OK in a short run, of 6 months or a Year, but not over 3-5-10 years -- then you are talking entire capital investment life-cycles.
Low interests rate are indeed preventing investment. Althought capital is readily available for borrowing, as the article says companies already have cash on hand as it is. Higher returns are needed to boost investment. Why do you think so many funds and banks are exploring developing nations. Higher returns.
Low interest rates are preventing investment by people who have money, sure. But in theory they do stimulate investment in new plants and equipment. If I can borrow money for almost nothing I can build a factory to make products that are barely profitable.
But the OP is right. Free money encourages waste. It encourages companies and governments to build things they can't really justify and can't afford to maintain. The real monument to Japan's lost decades is the amusement parks, golf courses, and rail lines that are crumbling because there was never enough demand to support them.
Indeed. A positive inflation (and a stimulus policy) make by themselves a case for waste. A negative inflation might favor resources conservation, or at least a better management.
It's a complicated topic - there was a great discussion about the inflation tax in a bitcoin article recently - http://news.ycombinator.org/item?id=4621674 where I was exposed to interesting new ideas by enki and snikto:
using up resources is not valuable by itself. forcing someone to spend on anything, anything at all, does not lead to a good allocation of resources. it might increase GDP, but it does not create value.
under inflationary interpretations of value creation, building a road circling back onto itself - not connected to anything - in the middle of a desert that no one ever visits - increases GDP and thus helps the economy. the better if you afterwards tear it up and rebuild it a second time.
on the other hand, in a stable currency system, if someone holds on to their capital, they actually free up resources for those who do spend. this means the purchasing power of those who do spend goes up.
in such a system money flows away from those who spend on things that have no return (consumption), and towards those who create (value creation by seizing and creating opportunities).
Maybe when comes the day where technology has not progressed enough to sustain economic growth and the extraction of resource should be rationalized (like say if we aren't mining asteroids in 100 years), there could be a case for a negative inflation rate.
I don't think this doughnut road is something anyone advocates, nor does it translate to something like Q.E.
Inflation by itself does a great thing: it reduces the real value of old debt. Q.E. just distributes the cost of forgiving debt away from dead people to everyone in an economy. In other words, monetary policy lets us avoid the moral hazard of stealing from the past.
Regardless if it stimulates investment in capital assets, with higher returns companies are able to absorb higher interest rates. It gets deducted off their taxes either way. The rates have been low for too long.
I believe he means that the expectation by the parent is for the child to perform well enough to get into an ivy league school, but the consequences of the child not performing well are non-existant (the bar being low).
A high interest rate means firms reduce their investment spending to avoid high interest payments ; or said otherwise rising interest rates lead to crowding out of private fixed investment.
I might be wrong - I'm quite new to macroeconomics
IS/LM and is not something that I would hang my hat on, here.[1] The reason is that the performance evelope of the firm must be considered micro-analytically. Ie, you need to take the perspective of the firm as a composite of capital investment projects. The aggregate value of the projects will be the value of the firm.
What impacts the decisionmaking of the firm? The spread between the cost of capital and the return on capital. For a fixed opportunity set of projects, a lower cost of capital will result in incremental investment provided that capital is available and capital projects are available that exceed the cost of capital.
How does one get these projects? In the real world, these are "hunted" like big game. These projects are either invented by engineering (new widget X) or they are extensions of current product (widget Y) that are sold to new clients (Z) by sales or bus dev.
Internally, the "green light" for these hunting parties is a hurdle rate (set to an average expected return-average cost of capital=some threshold level). Because there is uncertainty[2] in these big-game hunting expeditions, over time they will converge to the least amount of work necessary to clear the threshold. So, by this logic, the quality of projects will decrease over time as the threshold of project quality declines.
On the other hand, the external environment will also drive down this potential. Other companies will be increasing their hunting parties, increasing competition and reducing the probability of success.
The combination of these two factors, will over time decrease the performance envelope of the hunter/gatherer parties (be they engineers or sales/bus-dev). The issue is that this decline may have persistent effects (ie, learning by doing cuts both ways.)
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[1] See my footnote earlier. The IS/LM model assumptions and general methodology will not capture the recursive and inter-temporal effects on the opportunity set of projects that will follow from interest rates approaching zero artificially (ie, by fiat stimulus).
Very interesting. The "innovation" during low interest rate periods would still happen, but as you say would be a lesser kind of innovation, and with lasting persistent effects.
This could explain the current divergence in the GDP per capita curve (usually log linear) if we follow the idea that a continuous pace of innovation is necessary.
A quick wolframalpha graphing of the GDP per capita curve and federal funds rate shows in fact that the GDP per capita curve has inflections when interest rate quickly fall or go below 2.5%.
But considering that interest rates are used by the fed to try and fix the economy and thus highly correlated with high and lows, I don't know if there is a good way to check for this hypothesis.
It could also have bad consequences, since it predicts that countries with low interest rate (currently EU, US, JP) will experience a lesser form of innovation with lasting effects - and unfortunately I don't see interest rates going up, not with the current focus on low inflation.
It still is a very interesting concept. I would like to know more. Is there a name for the model you are describing? (or some links)
Think of the analogy of your Kid: Would you set the bar low and expect the kid to excel and get into Stanford? No. Thats now how it works. Without coaching, encouragement, benchmarking, and measurement, success is the exception not the rule.
Why is this so hard for DC to grasp? The empirical datapoint on this is clearly Japan in the 1990's. Ultra-low interest rates, and ultra-cheap capital might spur investment, but not <profitable> investment. Twice as much investment at 1/2 of the return on capital is not moving you anywhere.
That's a major part of the problem. USA have been facing this since the Greenspan stimulus following the Dot-Com crash in the early 00's.
_______
[1] This might work OK in a short run, of 6 months or a Year, but not over 3-5-10 years -- then you are talking entire capital investment life-cycles.