Investment goes up in response to higher interest rates? Really?

In fact, investment often rises when interest rates go up and volatility increases.

Obviously this defies conventional wisdom. Yet so wrote the Economist in their latest issue trying to debunk monetary policy as irrelevant and useless (and arguing instead for lower taxes and less onerous regulation).

This statement defies logic and seems to come from mixing up cause and effect. Of course if one studies historical data it will turn out that investment is highest at the top of an overheated cycle when businesses and investors get overexcited. That is precisely when interest rates go up because 1) demand for credit increases and so the price, i.e. interest rates go up and 2) central banks start worrying about over investment and try to discourage it by tightening in the form of increased interest rates. Yet that by no means demonstrates that in a recession a central bank can encourage investment by increasing interest rates.

To be completely fair, the Economist is merely presenting an academic opinion expressed by Mr Kothari of Sloan School of Management. It also does not explicitly state that higher interest rates cause increased investment but from the overall context of the article that is what follows.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s