The Interest Rate Ratchet in an Accelerator-Cash Flow Model of Gross Nonresidential Fixed Investment for the USA between 1950 and 1988

Abstract

Despite the reliance of most macroeconomic theories on the premise of an inverse relationship between investment and interest rates, such an ostensibly self-evident relationship rarely proves to be significant in econometric tests particularly with reference to plant, equipment, and non-residential fixed investment in the long-run.  Thus, this paper  tests a new model of the relationship between the rate of interest and long-term industrial investment, using both classical and Keynesian components, based on a data set from the U.S. economy between 1950 and 1988.   The sample is restricted to these years to examine this relationship in a semi-open economy before the onset of globalization.  This study henceforth concludes that the profitability of productive capacity currently in use and the rate of growth of the economy in previous years are much more important in explaining long-term fluctuations in the industrial investment than the rate of interest.  It also concludes that the institutional and economic environment plays an important role in explaining the decision to expand existing productive capacity.  Eventually, the way interest rates contribute to long-term fluctuations in industrial investment is complex, non-linear, and intermingled with other variables which take away from its explanatory power.