Old-fashioned Macroeconomics

Steve Roach argues for an old-fashioned model of investment spending.

Back in the Jurassic Era when I was the Fed’s capital spending analyst, we used to monitor a wide variety of capital spending models -- those driven by profits, cash flow, cost-of-capital considerations, and the stock market (Tobin’s "Q"). But the model that always worked the best was derived from the so-called "accelerator theory" -- that business fixed investment was most sensitive to improving demand expectations and the concomitant impact a rising output trajectory would have on capacity utilization. If pressures on existing capacity were likely to get more intense, then you probably needed more of it -- it was that simple. For all of the reasons noted above, in today’s subdued demand climate, the accelerator effect is likely to remain muted, thereby continuing to inhibit business capital spending.

On a personal note, I was Roach's research assistant at the Fed in the Jurassic Era.

Overall, Roach is arguing for another old-fashioned idea, which is that monetary policy is "pushing on a string" in trying to stimulate the economy. The notion is that when the economy is slumping and expectations are pessimistic, lower interest rates will not be sufficient to boost spending.

Discussion Question. Lower interest rates have the potential to boost consumer spending, housing investment, business investment, and net exports. What are the factors inhibiting each of these channels in today's economy?