Easy-money policies not the answer.

Author:Heffes, Ellen M.
Position:FINANCE - Companies view their future profitability with short term interest rates

U.S. corporate investment--one of the key engines of American economic growth--is largely dependent on how companies view their future profitability outlook, and has little to do with short-term interest rates or the availability of credit, according to new research by S.P. Kothari, a professor at the MIT Sloan School of Management.

The study, conducted by Kothari and his colleagues (Jonathan Lewellen at Dartmouth's Tuck School of Business and Jerold B. Warner at Rochester's Simon School of Business), looked at the growth rate of aggregate fixed investment by U.S. corporations between 1952 and 2010 and found scant evidence that short-term interest rates stimulated corporate investment after controlling for profits and stock returns.

This finding illustrates why moves by the U.S. Federal Reserve to reduce borrowing costs in an attempt to spur investment have not had the desired effect, notes Kothari. "The Fed sets interest rates with the hope of influencing investment, but in fact, the Fed has limited power over investment through its interest rate policies," he says.

"The biggest driver of corporate investment is the profitability outlook. When companies see opportunities to make money they invest; when they don't see opportunities to make money, they don't."

The study also refutes the notion that the massive drop in private sector investment following the financial crisis in 2008 was a response to the lack of available credit. Between the fourth quarter of 2008 and the fourth quarter of 2009, investment fell 23 percent...

To continue reading