Monetary Policy Actions and the Incentive to Invest

The "Value of Waiting" May Overwhelm Low Interest Rates

William R. Emmons and Frank A. Schmid

William Emmons is a Senior Economist at the Federal Reserve Bank of St. Louis. Prior to joining the Bank, he taught at Dartmouth College, Washington University, and St. Louis University. His publications have appeared in the Journal of Financial Services Research, the Journal of Institutional and Theoretical Economics, and the Journal of Consumer Affairs.

Frank Schmid is a Senior Economist at the Federal Reserve Bank of St. Louis. He was previously affiliated with the Wharton Financial Institutions Center, Free University Berlin, and the University of Vienna. He has taught at CERGE-EI, Johann Wolfgang Goethe-University Frankfurt, University of Osnabrück, and University of Vienna, among others. His list of publications includes papers in the Journal of Financial Economics, the Journal of Corporate Finance, and the Journal of Institutional and Theoretical Economics.

The ability of monetary policy actions to affect the private sector’s incentive to invest in fixed capital is hotly debated. Whereas a downward shift in the yield curve increases the present value of expected cash flows and should spur investment, lower short-term interest rates make delay more desirable. These influences work against each other, so the net effect of stimulative monetary policy actions could go either way. This article outlines a simple investment decision rule that captures both effects of changing interest rates. It also clarifies why monetary policy actions that shift the yield curve may or may not affect fixed investment.

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