DeLong rises to defend Ben Bernanke, against claims that unconventional monetary policy in recent years has discouraged businesses from investing. Business investment is doing just fine, he says:
As I see it, the Fed’s open-market operations have produced more spending–hence higher capacity utilization–and lower interest rates–has more advantageous costs of finance–and we are supposed to believe that its policies “have hurt business investment”?!?! … As I have said before and say again, weakness in overall investment is 100% due to weakness in housing investment. Is there an argument here that QE has reduced housing investment? No. Is nonresidential fixed investment below where one would expect it to be given that the overall recovery has been disappointing and capacity utilization is not high?
As evidence, DeLong points to the fact that nonresidential investment as a share of GDP is back where it was at the last two business cycle peaks.
As it happens, I agree with DeLong that it’s hard to make a convincing case that unconventional monetary policy is holding back business investment. Arguments about the awfulness of low interest rates seem more political or ideological, based on the real or imagined interests of interest-receivers than any identifiable economic analysis. But there’s a danger of overselling the opposite case.
It is certainly true that, as a share of potential GDP, nonresidential investment is not low by historical standards. But is this the right measure to be looking at? I think not, for a couple of reasons, one relatively minor and one major. The minor reason is that the recent redefinition of investment by the BEA to include various IP spending makes historical comparisons problematic. If we define investment as the BEA did until 2013, and as businesses still do under GAAP accounting standards, the investment share of GDP remains quite low compared to previous expansions. The major reason is that it’s misleading to evaluate investment relative to (actual or potential GDP), since weak investment will itself lead to slower GDP growth. [1]
On the first point: In 2013, the BEA redefined investment to include a variety of IP-related spending, including the commercial development of movies, books, music, etc. as well as research and development. We can debate whether, conceptually, Sony making Steve Jobs is the same kind of thing as Steve Jobs and his crew making the iPhone. But it’s important to realize that the apparent strength of investment spending in recent expansions is more about the former kind of activity than the latter. [2] More relevant for present purposes, since this kind of spending was not counted as investment — or even broken out separately, in many cases — prior to 2013, the older data are contemporary imputations. We should be skeptical of comparing today’s investment-cum-IP-and-R&D to the levels of 10 or 20 years ago, since 10 or 20 years ago it wasn’t even being measured. This means that historical comparisons are considerably more treacherous than usual. And if you count just traditional (GAAP) investment, or even traditional investment plus R&D, then investment has not, in fact, returned to its 2007 share of GDP, and remains well below long-run average levels. [3]
More importantly, using potential GDP as the yardstick is misleading because potential GDP is calculated simply as a trend of actual GDP, with a heavier weight on more recent observations. By construction, it is impossible for actual GDP to remain below potential for an extended period. So the fact that the current recovery is weak by historical standards automatically pulls down potential GDP, and makes the relative performance of investment look good.
We usually think that investment spending the single most important factor in business-cycle fluctuations. If weak investment growth results in a lower overall level of economic activity, investment as a share of GDP will look higher. Conversely, an investment boom that leads to rapid growth of the economy may not show up as an especially high investment share of GDP. So to get a clear sense of the performance of business investment, its better to look at the real growth of investment spending over a full business cycle, measured in inflation-adjusted dollars, not in percent of GDP. And when we do this, we see that the investment performance of the most recent cycle is the weakest on record — even using the BEA’s newer, more generous definition of investment.
The figure above shows the cumulative change in real investment spending since the previous business-cycle peak, using the current (broad) BEA definition. The next figure shows the same thing, but for the older, narrower GAAP definition. Data for both figures is taken from the aggregates published by the BEA, so it includes closely held corporations as well as publicly-traded ones. As the figures show, the most recent cycle is a clear outlier, both for the depth and duration of the fall in investment during the downturn itself, and even more for the slowness of the subsequent recovery.
Even using the BEA’s more generous definition, it took over 5 years for inflation-adjusted investment spending to recover its previous peak. (By the narrower GAAP definition, it took six years.) Five years after the average postwar business cycle peak, BEA investment spending had already risen 20 percent in real terms. As of the second quarter of 2015 — seven-and-a-half years after the most recent peak, and six years into the recovery — broad investment spending was up only 10 percent from its previous peak. (GAAP investment spending was up just 8.5 percent.) In the four previous postwar recoveries that lasted this long, real investment spending was up 63, 24, 56, and 21 percent respectively. So the current cycle has had less than half the investment growth of the weakest previous cycle. And it’s worth noting that the next two weakest investment performances of the ten postwar cycles came in the 1980s and the 2000s. In recent years, only the tech-boom period of the 1990s has matched the consistent investment growth of the 1950s, 1960s and 1970s.
So I don’t think it’s time to hang the “Mission Accomplished” banner up on Maiden Lane quite yet.
As DeLong says, it’s not surprising that business investment is weak given how far output is below trend. But the whole point of monetary policy is to stabilize output. For monetary policy to work, it needs to able to reliably offset lower than normal spending in other areas with stronger than normal investment spending. If after six years of extraordinarily stimulative monetary policy (and extraordinarily high corporate profits), business investment is just “where one would expect given that the overall recovery has been disappointing,” that’s a sign of failure, not success.
[1] Another minor issue, which I can’t discuss now, is DeLong’s choice to compare “real” (inflation-adjusted) spending to “real” GDP, rather than the more usual ratio of nominal values. Since the price index for investment goods consistent rises more slowly than the index for GDP as a whole, this makes current investment spending look higher relative to past investment spending.
[2] This IP spending is not generally counted as investment in the GAAP accounting rules followed by private businesses. As I’ve mentioned before, it’s problematic that national accounts diverge from private accounts this way. It seems to be part of a troubling trend of national accounts being colonized by economic theory.
[3] R&D spending is at least reported in financial statements, though I’m not sure how consistently. But with the other new types of IP investment — which account for the majority of it — the BEA has invented a category that doesn’t exist in business accounts at all. So the historical numbers must involve more than usual amount degree of guesswork.
Great post.
Thanks!
Two comments. First, ratio of two chain-weighted real quantities that Brad does is not even theoretically supportable. The real components of GDP do not add up to real GDP. You can only sum up the growth contributions, but the shares are nominal. So, you are right to bring that out. In fact, RBC guys routinely use the real/real ratio without the slightest awareness.
Second, I work closely withe the NIPA data and I have seen the progressive creep of economic theory crowding out real data. At this point, 16% of GDP is imputed. Also, NIPA pension accounting has massed up both the personal saving rate and state local government accounts. Here too there is large imputations. I think one day we will reach the stage where data will conform to theory and Prescott will no longer have to worry about theory ahead of data.
ratio of two chain-weighted real quantities that Brad does is not even theoretically supportable. The real components of GDP do not add up to real GDP. You can only sum up the growth contributions, but the shares are nominal
Yes, that’s right. But I didn’t want to get into it here. Anyway, DeLong presumably understands this, it’s the sort of mistake someone who writes as much as he does can easily make.
I work closely withe the NIPA data and I have seen the progressive creep of economic theory crowding out real data. At this point, 16% of GDP is imputed.
Have you seen this paper by Cynamon and Fazzari? http://www.boeckler.de/pdf/v_2015_10_23_fazzari.pdf
Yes, I have, thanks. there are many other issues, which make the NIPA data increasingly problematic. They also appear to “oversmooth” the data–US data are generally much less volatile on a month-to-month basis compared with other OECD countries. They just don’t let the data “talk.”
BTW, on the topic of real/real ratios, a recent paper purporting to show that “real” returns on capital are very high was highlighted by John Cochrane in his blog.
I am not an expert in this analysis so I’d be open to the possibility that you are right and DeLong is wrong about the level of business investment. But this sentence
“If after six years of extraordinarily stimulative monetary policy…”
I would disagree with and feel it would give the wrong impression to the layman and lets the Fed off the hook.
Monetary policy was “extraordinary” compared to previous recessions, but I believe they could have done much, much more.
I believe the Fed did the minimum required to avoid deflation – which happened to be a lot given the unprecedented austerity forced on the economy by Congress.
I believe in Bernanke’s book he describes how the inflation hawks pressured him to taper too soon. In essence financial conditions have been tightening ever since Bernanke began talking about tapering and they continue to tighten now as the Fed discusses liftoff.
Japan had more extraordinary monetary policy:
http://www.cepr.net/blogs/beat-the-press/employment-in-japan-has-surged-under-abenomics
Employment in Japan Has Surged Under Abenomics
by Dean Baker
Published: 26 October 2015
The NYT had a largely negative assessment of Abenomics, implying that it had done little to improve the state of Japan’s economy in the last two and a half years. The piece never mentions the surge in employment in Japan over this period. The overall employment rate for workers age 16-64 rose by 2.4 percentage points since the fourth quarter of 2012. This compares to a rise of 1.2 percentage points in the United States in a period in which the pace of job growth has been widely touted. If the United States had the same growth in employment rates as Japan under Abenomics, it would translate into another 2.4 million jobs.
Employment growth among women has been especially impressive, rising by 3.6 percentage points over this period. The employment rate for women is now a full percentage point higher than in the United States.
I think it’s great that Japan is letting more women participate in the labor force, and I agree that this is an important driver to economic growth (obviously).
But this has absolutely nothing to do with monetary policy or QE. The Abe government should get credit for this initiative, but not the BoJ.
Without agreeing that “unconventional monetary policy” diminishes investment, I tend to agree with the BEA. The filming of Seinfeld, for example, continues to generate income via royalties from TV reruns, online streaming services, downloads and DVD purchases, etc. Seinfeld is clearly an asset. At the dawn of broadcast/radio, shows had no economic value after they were shown, in which case it makes sense to view them as intermediate inputs. However that era is long gone and it’s good that the BEA has finally caught up to the post “Howdy-doody” model of mass media.
Similarly for R&D and in house software development. If a company hires some programmers to write software to better monitor the performance of apps in their datacenter, then isn’t that investment? If they purchased some heavy machinery — e.g. robots — that rolled around their data centers and took measurements, then this would be considered a capital investment. Again, it’s good that the BEA is catching up to reality.
Back to unconventional monetary policy, I don’t think it does much of anything. Monetary policy in a modern financial system is only about setting rates. Everything else is smoke and mirrors to “signal” that the CB is committed, etc.
I think it’s pretty interesting that the same folk who insisted that QE would “signal” that the CB was committed to generating excess *future* inflation and so affect the present economy in a ZLB are know urging for rate hikes, urging the CB to make a lie of promises for excess future inflation. I hope the same crowd remembers this lie the next time they argue that the CB can affect investment today by promising higher levels of future inflation. No one is going to believe the CB (or them), given the mass amnesia on display in our current rate-hike discourse.
My point isn’t that it’s wrong — I tend to agree with you on the merits of the new definition. My point rather is that the change makes me skeptical about long-run historical comparisons using the headline investment numbers. The old plant-and-equipment (or plant-equipment-and-software) definition might not be an exact fit to our preferred concept of investment, but it has the advantage that we can be fairly confident we are making an apples-to-apples comparison of present and historical values. So I think there’s an argument for looking at that if we want to evaluate investment as a share of GDP relative to some benchmark period in the past.
(I think it’s also desirable to keep the concepts in the national accounts close to the equivalent concepts used by private businesses in their financial reporting, but that’s not really relevant for this post.)
In any case, I think the stronger argument is the second one — that even if we use the BEA’s current definition, absolute “real” investment growth is extremely weak in this expansion — it only looks reasonable because growth is also very low.
Also, I probably should have made a bigger deal out of DeLong’s illiterate comparison of index numbers. The comparison of “real” investment to “real” GDP will depend on your arbitrary choice of base year.
Yes, I agree that business investment has been anemic, similar to the excessive corporate profits.
I think this goes hand in hand with low rates. E.g. the spread between risky rates and risk-free rates is itself a decreasing function of the risk-free rate. I think this is because as rates fall, distant earnings become more important, and these are necessarily discounted more than near-term earnings. So as you lower rates, you get diminishing returns in lowering risky rates and an increasing spread. That’s my theory.
In terms of normal accounting, I think the market does consider R&D spending to be a capital expenditure, and hence the emphasis on operating margins and revenues rather than earnings for a lot of tech companies — combined with the complaints of those not familiar with this for why tech companies enjoy such high multiples.
Interestingly, here is a proposal: http://people.stern.nyu.edu/adamodar/pdfiles/papers/R&D.pdf
I agree that you can’t compare indexes — even if you used the same base year, it doesn’t make much sense.
the spread between risky rates and risk-free rates is itself a decreasing function of the risk-free rate. I think this is because as rates fall, distant earnings become more important, and these are necessarily discounted more than near-term earnings. So as you lower rates, you get diminishing returns in lowering risky rates and an increasing spread. That’s my theory.
That’s a good theory. I think there’s definitely something to it.
I think the market does consider R&D spending to be a capital expenditure
R&D is ok — that’s already reported by businesses. I’m more concerned about the other IP stuff — which seems to be the larger portion of the new “investment” spending — where the BEA has invented a new category of spending that doesn’t exist in private accounts at all.
I’m more concerned about the other IP stuff — which seems to be the larger portion of the new “investment” spending
That makes sense. It’s a huge category and I don’t know how it’s currently accounted for. I’d guess production costs of NBC Nightly News shouldn’t be viewed as an investment, but production costs for House of Cards should be. There is a lot of opportunity for confusion here.