Evan Soltas
Mar 30, 2012

Investment Starvation

The case for aggressive monetary policy now

The Austrians, my understanding is, like to talk about the need for savings to precede investment, and that we haven't recovered because we haven't worn our hair shirts saved for long enough, or we haven't repented for our sins liquidated our malinvestments.

I really wish they would learn to look at data.

The fact is, we've got a historically large private sector financial surplus as a percentage of gross domestic product -- all this gross private saving amid a shortage of gross private investment. 5.7 percent! It makes me want to tear my hair out in frustration sometimes, as this is what countercyclical monetary policy was created to correct.

We know that the level of savings is not sensitive to interest rates in the short run, due to income and substitution effects which run in opposite directions and cancel each other out. But investment is highly sensitive to real interest rates, yet as a component of GDP, private investment continues to lag well behind the rest of the recovery.

We're starving this recovery of private investment -- and, whether the Federal Reserve knows it or not, choosing to do so -- which is a simply terrible idea. Unlike Paul Krugman, who used our massive private financial surplus to argue for more government investment, I don't think that's the right way forward. First, I'm not as comfortable with the idea that there is no effective distinction between private and public investment. It was one of Keynes' fundamental policy recommendations that government socialize investment (I'm reading The General Theory), and it's one I don't think makes a lot of sense outside of the model, to put it baldly.

Roads and schools are important, but so are factories and offices. In public and private investment, neither one fully replaces the other. Yes, I would concede to Krugman that we've shortchanged ourselves to some extent on the former and would benefit from more state and local investment, but that won't come even close to making up for all of the investment we need. This is by in large a private-sector problem.

Nondefense public investment has consistently made up 2.5 percent of GDP. The gap we need to fill is more than twice that size, and I am not confident that this is a matter fiscal policy can solve, given the stimulus didn't push nondefense public investment above even 3 percent.

Most of the gross private saving is in corporate hands, and the surest way to incentivize investment, and to get this market to clear out the massive financial surplus, is to make investment cheaper by further depressing real interest rates.