In the headlines of today, every participant including speculators, governments, institutions and even public is enquiring about the current market conditions and its developments. “Some are optimistic and some complaining about it”. This article presents a brief description based on interest rate, Investments and Fed hikes.
In 2008 Dec Fed had lower the rate and continued until Nov 2015, where Fed started the hikes. At the heart of the 2007 financial crisis Fed had to buy various kind of assets through some larger scale quantitative easing programs, typically by lowering the policy rates. According to Former Fed chairman Ben Bernanke, many researches and academics has hypothesized that lower rates have cool down the markets which already heat up for chaos. But every coin has its own two sides, now we have to carefully examine the shadow events that operated under these lower rates from 2008, since lower rates continued for long period of time. Here I have examined some activities in form of Investments, borrowings and consumption.
Investments (Public, residential & Business) – Why inflation remained at a lower rate after the recession?
In Macroeconomics, Investment defined as flows for adding new physical stock of capitol. Lower interest rates imply higher Net Present Value of particular projects. So
private companies have potential to expand their productions or services. Financial Institutions which provide funds for public operations also happy with lower rates.
These projects can be finance through borrowings, retained earnings and selling shares in a bullish market. Hence, we are analyzing the global economy after the Great Recession, variables might not be same as in a normal boom and bust cycle. According to latest data, business Investment ratio to GDP in advanced economies are still below its long run level of 12%. But it is expanding gradually. In U.S., peak of the gross domestic investment on domestic business recorded in Q1 of 2018 which is $2,688 Billion.
Investment spending is the key source in advanced economies for recent advancement on global GDP. But question remained is the productivity and efficient allocation of such investments, so public can benefited in terms of productivity in the long run. Since U.S. economy fall in to the liquidity trap with the recession, it demanded fiscal support for the recovery. Obama admin respond to the situation with Recovery and Reinvestment act in 2009. The package was based on $288 bn of tax cuts, $224 bn spending on unemployment benefits, education and health care. Allocating $275 bn in federal contracts (constructions), loans and grants to reduce unemployment. Intention of this stimulation was to increase Aggregate Demand function. Increase in consumption (Durables or residential Investments) has to be vulnerable through such policies, so by turn it can increase Business Investments. In order to facilitate the funds from lenders to borrowers, intervene for the financial sector to build trust and capital requirements also needed after the recession (Ex Treasury TARP). But following points are made out by researchers.
- Initial data showed that Business Investments are picking up at a greater phase than residential Investments, result in weakening the Aggregate Demand, which in turn questioning the policy implications. Residential Investments are increasing in consumer durables rather than real estates, allowing allocations from housing industry to durables. But problem was the slowdown of this reallocation (Matthew Rognliey, 2015).
- The tax relief initiated to increase the consumer spending, but some analysis shows that, due to such tax relief program, many consumers did not realize the wealth has been increased (ex. Workers did not get the checks). So it didn’t increase the consumer spending to the desired level.
Consequently, consumer spending has slowdown in recent years. Therefore, the core inflation also remained lower level in U.S. recently.
Decision making on business Investments
In terms of business Investments, According to some neo-classical models such as Samuelson (1939) , and other Aggregate Supply models emphasize that firms will anticipate the future output deviation. In other words, firms are synchronizing the expected market demand in its decision making on prices and output. Keynes also stated that decisions of business investments depends upon the individual decisions to consume or save. In this sense, weaker demand in recent years after 2009, would lead to sluggish growth on business investments.
Apart from the macroeconomic factors, other exogenous factors also have an impact on Investments. For instance Financial conditions also playing a huge role in investment decision making. McKinnon ( 1973) showed that fiancé growth and economic growth are positively co related, also can be defined as “supply leading hypothesis”. Business has to make Investment decision with retained earnings and borrowings. In IMF working paper Kopp(2018) stated that, after the recession, firms used its retained earnings to increase its financial position rather than re- invest on productive matters. Ex. Larger dividend payouts & share buyback. But it’s a controversial that shareholder payouts and buy backs have an impact on capital expenditure by firms. In same paper Kopp stated that Tighter lending conditions couldn’t explain the Investment behavior. So tight financial condition is not related with business investment. Perhaps credit availability of the markets through quantitative easing programs might put upward pressure gradually for Investments even though financial conditions are tight.
Productivity and Investments
Another important aspect on business Investment is its productivity. Following graph represent the Change in Investment for Innovations, including Intellectual property.
Above graph revealed that average rate on Investments on productivity based on R&D and innovations are high in 1970-1990 period while this average has reduced over the years after 1990. (Described in two red lines in above figure). Fourth Industrial revolution took place in 1980s driven by internet and the computers. So huge amount of capital has pumped in to R&D, innovations and manufacturing in those sectors. But it is disputable that why it has reduced over the years after 90s. Majority of arguments are based on following underline facts.
- In advance phase on IT (at 4th industrial revolution) most internet-based companies expanded and matured itself.
- After China had enter in to WTO in 2001, most U.S. manufacturing shifted to China.
Debt management is a major topic among every government and corporation since 2007 great resection and European debt crisis. There are vulnerability of lower interest rates to some identical risks. For an example FED had lower the rate from 2000 Dec and continued until 2004 Jun. Many blamed for these lower rates, since they believe that it was the major factor for 2007 financial crisis. In order for recovery, FED again reduced the policy rates and continued until 2015 Jul. Still it’s not near FEDs long run level. Let us examine two periods of the lower rates. Pre-recession and post-recession periods. But note that post- recession economy is not the same
as pre-recession economy. The following two figures represent the total debt outstanding and total borrowing by all sectors of the economy including federal government.
|Pre – recession period, debt outstanding||Post – recession period, debt outstanding|
|Pre – recession period, total borrowings||Post – recession period, total borrowings|
As per above two figures it is clear that today’s debt outstanding is more than pre-crisis level. It has been drastically increased after 2010. So debt is keep adding to its balance sheets in all business and public over recent years. It is observable that excess liquidity created by the FED has absorbed in all sectors of the economy. So debt was kept adding on top of the debt that still not matured, resulting in higher debt outstanding than pre-crisis level.
“These imbalances in U.S economy have playing a major role in every policy decision undertaken by any state. Above stated review is helpful to get a picture for further studies and research on financial economics by considering long chain of events after the great recession”.