Fed’s Low Interest Rates Don’t Spur Business Investment
On Wednesday the Federal Reserve’s Federal Open Market Committee issued a release detailing its future course. The release stated that because of slight improvements in economic growth, employment, and spending, the members decided to taper their monthly bond purchases by another $10 billion, echoing December’s
reduction. No mention of the turmoil in emerging markets or the declining labor force participation rate. The Federal Reserve will now purchase $30 billion in mortgage-backed securities and $35 billion in long-term Treasury securities each month.
The Fed will continue reinvesting principal payments from its debt and rolling over Treasury securities at auction. According to the release, its “sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery.”
The FOMC believes that if it can keep long-term interest rates low, business investment—which has been sorely lacking in this recovery—will increase and the economy will grow. But two Federal Reserve economists, Steve Sharpe and Gustavo Suarez, find little real-world evidence that low interest rates encourage business investment. Their new paper brings into question a central tenet of macroeconomic monetary policy—that higher interest rates reduce business investment and lower rates spur investment.
Sharpe and Suarez use data from the September 2012 Duke University CFO Magazine Global Business Outlook, which interviewed more than 500 CFOs. They controlled for firms’ financial conditions and interest rate sensitivities and found:
• Only 8 percent of respondents would increase business investment if interest rates fell by up to 1 percentage point
• 16 percent would increase investment if rates fell by up to 2 percentage points
• 68 percent said declines in rates of any amount would not increase investment
• 16 percent would reduce investment if rates rose up to 1 percentage point
• 31 percent would reduce investment if rates rose up to 2 percentage points
The economists followed up their analysis by evaluating September 2013’s Global Business Outlook survey. In the year between the surveys, interest rates of both Treasury and investment-grade bonds rose about one percentage point. The results supported their initial findings and, if anything, showed less business investment reduction when interest rates increase.
These findings add further evidence to the Federal Reserve’s inability to singlehandedly create economic growth. Its role is to execute sound, consistent monetary policy. Four and a half years after the end of the recession, it is up to Congress to put in place policies that increase private and business investment. Providing special tax breaks for certain industries such as alternative energy or manufacturing, as President Obama suggested in his State of the Union address on Tuesday, will not accomplish this. Solutions to spur business investment include lowering America’s combined federal and state corporate tax rate (39 percent) to the OECD average (24 percent), and cutting back unnecessarily burdensome federal regulations which discourage growth.
Despite President Obama’s words in yesterday’s State of the Union address, U.S. multinationals are creating more jobs overseas than in the United States. This is not “the first time in over a decade [that] business leaders around the world have declared that China is no longer the world’s number one place to invest; America is.” In 2011, U.S. non-banking multinational companies employed 11.6 million foreign workers, a 50 percent increase from 12 years ago. Employment by these companies of domestic workers slightly declined over the same period, from 23 million to 21.7 million.
To avoid a hefty repatriation tax bill, companies such as Apple invest their foreign-earned cash overseas in lower-tax countries. These investment and job gains could be seen in America if taxation and regulatory burdens were lessened. According to the Heritage Foundation, the U.S. business environment has deteriorated so far that the United States is now ranked 12th in terms of economic freedom. Countries such as Denmark, Chile, and Estonia are rated higher.
With the labor force participation rate at 1978 levels, and 1.2 million fewer jobs in the economy than before the recession, Congress should be doing all it can to encourage business investment. Instead, representatives and senators punted their responsibilities to the Federal Reserve—an unelected organization with no business conducting fiscal and regulatory policy.
At this stage of economic recovery, the Federal Reserve’s continued accommodative monetary policy is unlikely to increase GDP or employment growth. It is time for a change in course—for both the Federal Reserve, Congress, and the president.
Jared Meyer is a policy analyst at Economics21, a center of the Manhattan Institute for Policy Research. You can follow him on Twitter here.
