Investment, interest rates and the accelerator: more evidence for the US

Not that is really necessary. But the evidence continues to be overwhelming. Christian Schoder in a recent paper (here; subscription required), following in the steps of the classic paper on the subject by Fazzari et al. (1988) and looking at the micro data on investment concludes that:

"Overall, demand constraints seem to be crucial factors contributing to the slowdown of accumulation in times of economic distress relative to credit market conditions. In contrast to the prediction of the financial accelerator literature that credit constraints tighten in the downturn (relative to demand constraints) as net worth deteriorates, the cash-flow coefficient does not exhibit a clear counter-cyclical pattern.

We further find that the most tremendous declines in business investment which occurred in the contexts of the recessions in 1982, 1990, 2001 and 2008/09 were driven by the demand side of the capital market rather than the supply side since, during these times, an improvement of investment opportunities reflected by an expansion of sales growth and Tobin’s q, on average, induced firms to raise investment to a disproportionately large extent whereas an easing of credit constraints, on average, provoked only a disproportionately small expansion of investment."

In other words, cost of capital variables, that are measured at the firm level using a CAPM model and approximating by the ratio between interest payments and stock of debt, are not significant. Sales, i.e. demand, is what drives investment. And yes that means that more government demand was needed. In his words:

"The results suggest that investment tended to be driven by adverse demand rather than supply conditions during the most severe recessions. Especially, the decline of investment after the financial meltdown in 2007–2008 is associated with inferior demand conditions compared to supply conditions. This view is consistent with the chronicles of US fiscal and monetary policy stance regarding the management of aggregate demand and credit flow. Our policy evaluation implies that the policy attempts to stabilize demand were insufficient in order to stabilize investment in the recent economic crisis."

That's what the recent evidence suggests. No surprises here.