Rediscovery: Monetary policy often is not sufficient to spark economy



To jump-start our economy, the Federal Reserve System uses the time-honored method of low-interest rates in combination with flooding banks with lendable reserves. Called monetary ease, of which every student of Economics 101 is aware, it teaches that this should be sufficient to bring recovery.

But every student also is taught that this action may not be adequate to assure a boost in economic activity, in gross domestic product or in employment. In short, it may fail miserably to lift business investment, such as expenditures on new plant and equipment. Meanwhile, institutional investors and retail investors are each saturated with cash, which they may invest in financial assets instead of productive real capital.


THIS OBSERVATION has been rediscovered by Kevin Warsh and Stanley Druckenmiller (The Wall Street Journal, June 20, “The Asset-Rich, Income Poor Economy”). They remind us that while the Fed can provide the economy cash, if corporate chieftains use their borrowings to finance stock repurchases, there is no investment in plant and equipment, no increases in economic growth and no boost in employment.

This account of failed investment, however, is inadequate. It fails to explain why, even when CEOs are armed with bags of cash, they disdain from investment spending. This is crucial to understanding why our recovery from recession is so sluggish, so halting and so disappointing. Over the past five years, plenty of cash has been available to corporations at historically low, near-zero rates of interest; yet corporate investment spending founders. Why are proposed corporate investments so unattractive to our CEOs?


ROUGHLY SPEAKING, to an economist, investment is a commitment of the firm’s resources not to obtain an immediate payoff, but instead a series of payoffs over future periods. Investment means expansion of the business, which translates into greater economic growth in GDP, and increases in employment. These are powerful expenditures which is why economists focus so much attention on them.

But they also give attention to federal deficit spending as a means of stimulating consumption, which was overwhelmingly believed sufficient to spark investment. It has failed, and we explain why.

The bottom line of an investment idea still consists of its expected revenues minus its expenses. The most volatile element in this expression is expenses or, if one prefers, its costs. And the component of cost that drives corporate CEOs crazy is taxes, along with the staggering growth of government regulations.

Of course, when planning a business investment these costs are expectations, for little today is normally known with certainty. And with politicians threatening new and increased taxes, and new regulations, the risk of achieving satisfactory risk-return outcomes for proposed investments skyrockets, leading to the rejection of these opportunities.

Ironically, the principal factor behind this dismal background has been government taxation policies – high tax rates, riddled with special-interest deductions, credits and exemptions, and topped off with juicy morsels of crony capitalism. To make matters worse is the unrelenting threat of costly new regulations (witness the negative effect the prospect of higher minimum wages brings forth).


WITNESS ALSO THE trillions of dollars held by U.S. corporations abroad because they are subject to taxes when returned to this country. Rather than invest funds in the United States, a growing number of firms are reincorporating abroad to avoid U.S. taxes. And these examples are only starters.

Originally, it was assumed that when the Fed executed these powers that actions by Congress and the president would, at least, be accommodative to Fed policy, not a stubborn hindrance. And to be accommodative means to provide a fiscal, tax and regulatory environment that encourages the borrowing of these extraordinary, low-interest-rate funds for investment purposes. The key phrase here is “investment purposes.”


WE ARE OVERWHELMED with statistical evidence demonstrating the inadequacy of current business investment. There also has been a striking failure in the formation of new small businesses, the virtual lifeblood of dynamic, new innovations that spark business spending on a continual basis. See, for example, Edward C. Prescott and Lee E. Ohanian (The Wall Street Journal, June 25, “Behind the Productivity Plunge: Fewer Startups”).

They report a 30 prcent
decline in 2011 (the latest data available) compared to the average rate for the 1980s. These innovations require imagination, creative talent and the doggedness to develop, follow through and execute. But they also require a stimulative, incentive-reward process – low taxes, absence of threats to reduce rewards and fewer costly controls.

Overall, our current headlong dash toward a more authoritarian state stifles new, small businesses, innovations, risk-taking enterprise and growth in productivity, employment and GDP – all markers of happy outcomes.

All of these consequences portend a more tragic outcome: By stifling the formation of small businesses, readers easily can discern that we plant the seeds for slowing future business startups. Little known is that this will act as an added drag on GDP growth and private employment. Shortsighted public policy leads to depressive effects on the rate of new business enterprise growth, and contributes to a further slowing of private investment in the long run.


IF MONETARY POLICY is to have any chance of being effective, it must have the cooperation of a genuine accommodative tax and regulatory policy. This means recognizing the overwhelming importance of low taxes and a slowdown in the growth of costly, runaway government regulations. There is need for a more cost-effective regulatory policy (stop dropping atom bombs to kill a fly; and especially, avoid such bombs where there are no flies.)

In other words, we need vast “structural reform.” But our current policies move us in the opposite direction, leading to low private investment, halting growth in GDP and in employment. In our current environment, it is virtually impossible for monetary policy alone to achieve a powerful recovery.


(The writer is a professor emeritus of financial economics at the University of Georgia. He lives in Aiken, S.C.)



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