Low interest rates are destroying our economy

We’ve written a lot here about the failure of the corporate world to invest. There have been a few attempts recently to suggest the problem isn’t that bad after all (subscribers can read a lot on this in last week’s roundtable). But most of the numbers economists look at suggest that business investment is still very low indeed. Why?

We are strong supporters of the story Andrew Smithers tells in his new book Road to Recovery. To him, the main problem relates to executive compensation – if we incentivise them to keep short term profits up (by paying them in share options) we also incentivise them not to do any of the things that might reduce short term profits – investing in new capital equipment being the obvious one.

But more recently we have also argued that low interest rates themselves prevent investment. That’s partly because of their effect on the liability calculations for final salary pension funds (see my post on this here). But having interest rates at a 300-year low might also be bad for confidence in general.

A note from the managers of the WDB Oriel UK Fund puts it like this: “As long as monetary policy is artificial, the climate for corporate investment remains sufficiently uncertain that companies seem deterred from committing capital; much easier, in the event of demand growth, to add capacity via additional labour especially in those jurisdictions where hiring and firing is relatively unconstrained by legislative diktat. Perhaps this explains the strength of private sector employment co-incident with continuing pronounced weakness in corporate investment.”

Take this a bit further and you see that as long as interest rates remain so low that a nervous corporate sector eschews investment, capital will remain plentiful, thereby underpinning equity and house prices.

However “the key intent of monetary policy – sustained, balanced economic growth” will remain elusive.