The Fed's Low Interest Rates Do Not Encourage Investment

February 7, 2014

A new study indicates that low interest rates do not encourage business investment, says Jared Meyer, a policy analyst at Economic Policies for the 21st Century.

The Federal Reserve announced recently that it will taper its bond purchases by $10 billion and continue a policy to keep interest rates low. By keeping long-term interest rates low, the Fed believes that business investment will increase, stimulating the economy. However, a study by two Federal Reserve economists has actually found that there is no evidence to indicate that low interest rates encourage investment.

Meyer reports that the study by Steve Sharpe and Gustavo Suarez undermines the widespread notion that high interest rates reduce investment. After analyzing September 2012 data that included interviews with over 500 CFOs, the researchers found:

  • Only 8 percent would increase business investment in response to a 1 percent drop in interest rates.
  • Sixteen percent would increase investment in response to a 2 percentage point drop in interest rates.
  • Sixty-eight percent said that they would not increase investment at all, no matter the decline in interest rates.
  • Sixteen percent would reduce investment if interest rates rose up to 1 percentage point.
  • Thirty-one percent would reduce investment if rates rose up to 2 percentage points.

The study is further evidence that the Federal Reserve cannot singlehandedly create economic growth. Instead, Congress should be the one crafting policies that increase investment, such as lowering the corporate tax rate and peeling back unnecessary regulations. For example, because the United States imposes taxes on companies that repatriate their overseas earnings, companies that earn income overseas also invest that income overseas in countries with lower tax burdens.

The Federal Reserve's monetary policy is unlikely to increase growth. Congress should be the one crafting fiscal policy that actually encourages investment and strengthens the economy.

Source: Jared Meyer, "Fed's Low Interest Rates Don't Spur Business Investment," Economic Policies for the 21st Century, January 29, 2014.

 

Browse more articles on Economic Issues