Why investment expenditure is insensitive to monetary policy

The June quarter 2015 edition of the Reserve Bank of Australia Bulletin has an interesting article – Firms’ Investment Decisions and Interest Rates – which further erodes the mainstream economics claim that business investment is negatively related to interest rates in any continuous way. The implications of the RBA research are many. First, it further helps us understand why monetary policy (adjusting interest rates) is not a very effective way of managing aggregate spending. Second, the research undermines the validity of the mainstream claims that crowding out of private expenditure occurs when government spending rises. The paper finds that investment decisions by firms is not sensitive to interest rate variations within certain ranges. Third, it demonstrates that business investment is driven significantly by subjective sentiment rather than being an exact process driven by quantifiable metrics.

The Bank has commented on the fact that expenditure in Australia does not appear to be particularly responsive to the interest rate changes in recent years.

Interest rates are now at record lows as the RBA attempts (in its own logic) to stimulate growth in the face of subdued private domestic demand, an external deficit and a government intent on imposing fiscal austerity.

The economy has now been operating at well below trend growth rate and unemployment has been rising as private investment growth goes negative as a result of the massive investment in the mining sector ended.

The RBA believed that it could “re-balance” the economy from mining investment to more investment in productive capacity in the non-mining sectors through monetary policy changes (interest rate cuts).

But despite the record low interest rates, non-mining investment growth went negative in the latest national accounts data release and the firms have indicated in recent surveys that they are intending rather large cuts in investment expenditure in 2016.

Please read my blog – Australian National Accounts – the fragility of growth increases and Friday lay day – Australian RBA Governor concludes government policy is failing – for more discussion on this point.

The last blog cited records the frustration of the RBA Governor with the Government. He recently admitted that monetary policy alone will not be sufficient to provide an expenditure stimulus and that there was a need for more fiscal stimulus – larger deficits targetted at public infrastruture investment.

Mainstream economists struggle to understand any of this. For them business investment is inversely related to interest rates and with the downward movements in interest rates in the last two years, it is difficult for them to explain the negative growth in investment.

For Post Keynesians, including Modern Monetary Theory (MMT) proponents there is no difficulty in understanding what is going on. I have said for a long time that monetary policy is a largely ineffective policy tool for stimulating or reducing aggregate spending in the economy.

Please read my blog – Monetary policy is largely ineffective – for more discussion on this point.

Business investment is cost sensitive no doubt. But what the mainstream economists usually ignore is the fact that expectations of earnings are also important as are assymetries across the cycle.

The cyclical asymmetries in investment spending arise because investment in new capital stock usually requires firms to make large irreversible capital outlays.

Capital is not a piece of putty (as it is depicted in the mainstream economics textbooks that the students use in universities) that can be remoulded in whatever configuration that might be appropriate (that is, different types of machines and equipment).

Once the firm has made a large-scale investment in a new technology they will be stuck with it for some period.

In an environment of endemic uncertainty, firms become cautious in times of pessimism and employ broad safety margins when deciding how much investment they will spend.

Accordingly, they form expectations of future profitability by considering the current capacity utilisation rate against their normal usage.

They will only invest when capacity utilisation, exceeds its normal level. So investment varies with capacity utilisation within bounds and therefore productive capacity grows at rate which is bounded from below and above.

The asymmetric investment behaviour thus generates asymmetries in capacity growth because productive capacity only grows when there is a shortage of capacity.

This insight has major implications for the way in which economies recover and the necessity for strong fiscal support when a deep recession is encountered.

So with the Government articulating its intention to savagely cut into expenditure and with incomes falling due to rising unemployment and falling terms of trade, it is little wonder that investment growth is negative at present in Australia.

These dynamics are covered in my 2008 book with Joan Muysken – Full Employment abandoned.

The RBA has therefore come to the party somewhat late if it really believed cuttig rates would reverse the decline in economic growth.

In the RBA paper cited in the introduction, the researchers address the apparent insensitivity of investment spending to interest rates cuts by aiming to undertand the way in which business firms “evaluate investment opportunities”.

They use survey data – that is, actually ask firms to articulate how they male investment decisions.

This is a good sign – get out and try to understand the way the real world operates rather than consider what appears in textbooks (other than the one Randy Wray and myself are writing that is :-)) has much at all to say about reality.

The results are very interesting and telling. Telling, in the sense, that they provide further evidence as to why monetary policy is an ineffective tool for stimulating national expenditure.

And, importantly, the results provide further evidence against the mainstream ‘crowding out’ hypothesis, which claims that government expenditure pushes up interest rates (because it allegedly competes for scarce savings) and the higher interest rates deter private investment in productive infrastructure.

We know the first part of the story is false – there is no competition for scarce savings because rising income (on the back of increased spending) increase savings. Further, bank lending is not reserve constrained which means the banking model that says they are institutions that wait around for savers to deposit funds, which they can then loan out to investors is false.

Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.

The RBA paper adds further understanding to why total expenditure (including private investment) is relatively insensitive to interest rate changes – the second part of the ‘crowding out’ hypothesis.

It is very interesting just in that aspect.

The RBA paper describes the “Bank’s business liaison program”, which involves “around 70-80 discussions with contacts on a monthly basis … Liaison meetings are held with firms of all sizes, although most discussions are with mid-sized and large firms where conditions are somewhat more likely to reflect economy-wide trends rather than firm-specific factors.”

The paper says that:

… many contacts have reported that low interest rates do not directly encourage investment. In contrast, economic theory suggests that the rate of interest affects the cost of capital and should influence investment decisions directly, based on standard methods used to evaluate investment opportunities.

Detailed discussions with business liaison contacts reveal why lower interest rates might not have any direct effect on investment, even at the margin. Contacts indicate that required rates of return on capital expenditure, also referred to as ‘hurdle rates’, are often several percentage points above the cost of capital. More importantly, contacts note that the hurdle rate is often held constant through time, rather than being adjusted in line with the cost of capital.

That is the summary. What follows is the more detailed explanation.

Students learn so-called Discounted Cash Flow Analysis (DCF) and payback period analysis as part of their studies in capital theory – learning how investment decisions are made.

The basis of DCF is that there is a time value to money – a dollar now is worth more than a dollar in a year (because it can earn a compound return if invested now). So revenue or costs in future periods cannot be readily compared with revenue and costs now.

So when a firm is evaluating future returns (cash flows) and outlays (costs) it has to bring them back into a comparable monetary unit, which is called the – Present Value – of the income and outlays.

To overcome this temporal issue, we define a present value by ‘discounting’ future cash flows to take into account the ‘time value of money’ and ‘investment risk’.

We thus use some interest rate (discount rate) to bring all future revenue/outlays back to a present day value. You can look up formulas to see how this is done if you are interested.

The net present value (NPV) is just the sum of the revenues (in present value terms) minus the sum of the outlays (also in present value terms). The NPV indicates the value on a long-term project and if the NPV > 0 then the project adds value to the firm.

There is a huge debate about the short-comings of NPVs as a guide to capital expenditure. I will leave it to your curiosity to pursue the literature further should you be interested.

DCF uses a ‘discount rate’ (an interest rate) chosen by the firm to be representative. As we will see the choice of the discount rate is not uncontroversial.

Governments often use very ‘favourable’ (aka studidly unrealistic) discount rates if they want a dubious investment project to meet its business case. I have been involved in court actions (appearing for community groups) where the decision to privatise a community hospital was made on ridiculous discount rates, which made the project appear incredibly profitable for the private operator whereas when a more realistic discount rate was used the project was clearly going to crash. The government went ahead in that case and a few years later the private operator went broke and the government had to ‘buy’ the hospital back. Meanwhile, the private operator walked away with massive public subsidies. It was outrageous. An aside.

In the context of this blog, one such issue is that NPVs do not tell you the profit in percentage terms of investing in a specific project. They merely indicate the value of an investment. They do not provide information about the efficiency or yield of the investment. In this context, the use of the internal rate of return is indicated in the literature.

The – Internal Rate of Return – is often referred to as the “the discounted cash flow rate of return (DCFROR) or simply the rate of return (ROR)”.

Imagine you want to know the break-even discount rate where the present value of all outlays equals the present value of all revenue. That discount rate is the IRR. The higher the IRR, the more desirable the project.

The finance literature claims that a firm should undertake all projects where the IRR > cost of capital.

Discounted cash flows are thus adjusted future cash flows (returns or outlays) to bring the monetary sums back into what they are worth in today’s dollars. I won’t go into all the technicalities but the essential point is that DCF provides the analyst with a single present value of the complex future cash flows associated with an investment project (a dollar value) which can then be compared with other alternative uses of the funds.

So two or more investment projects might have very different future patterns of cash flows but can still be compared using the net present value, which is the difference between the present value of the returns less the present value of the outlays over time.

The RBA say that:

In the simplest case, the firm should invest if the NPV is positive for the chosen discount rate; put differently, the project should be approved if the internal rate of return of the project is above this specific discount rate.

For obvious reasons, the RBA calls this discount rate – the hurdle rate. It is the rate beyond which the IRR will invoke a decision to invest.

That seems to be logical.

The next logical point is that:

Theory suggests that the hurdle rate for a typical investment should be set with some reference to the firm’s weighted average cost of capital (WACC), which includes the cost of both debt and equity. For example, the level of the hurdle rate may be greater than the WACC if the potential investment has greater non-diversifiable risk than the overall operations of the firm. The extent of such a gap will also depend on the extent to which managers and shareholders are averse to risk. Changes in interest rates influence the cost of debt and, under reasonable assumptions, the cost of equity, and so should influence the hurdle rate.

The essential point is that for a given risk environment, interest rate cuts that reduce the “firm’s weighted average cost of capital” should also lower the hurdle rate, which means that less profitable investment projects at higher capital costs become attractive and investment rises.

That is the theory.

What is the evidence?

Interestingly, the RBA report that the typical Australian firm does use DCF analysis to assist in their investment decision making. They say this consistent with evidence from the UK and the USA.

But, and this is the point:

Liaison contacts indicate that the hurdle rates used to evaluate business investment opportunities are often several percentage points above the WACC. Hurdle rates of around 15 per cent are quite common.

Around “90 per cent of Australian corporations … used hurdle rates exceeding 10 per cent, and around half … used a hurdle rate exceeding 13 per cent”.

And, even more significantly:

Many liaison contacts also report that hurdle rates are not changed very often and in some instances have not been altered for at least several years.

So firms are using decision making discount rates far in excess of the actual cost of capital and have not updated that discrepancy in the light of the new low interest rate environment.

The RBA reports that “nearly half reported the level of their hurdle rate was changed ‘very rarely'”.

Which means that “changes in interest rates do not flow through to hurdle rates; rather, the margin between the WACC and the hurdle rate changes” – that is, it gets wider.

The RBA reported that firms told them they do not change their decision making rates in line with interest rate changes because they regard the latter as “temporary, and so they are reluctant to react to developments that may soon be unwound”. Other reasons were given.

This all means that calculations of NPV (and IRRs) are insensitive to real world conditions.

Moreover, while firms do use DCF analysis the RBA said that:

It is clear from discussions with managers that the overall investment decision process is often highly subjective, introducing a role for ‘animal spirits’ or ‘gut feeling’ to have an important effect on capital expenditure decisions. This is not surprising, given that future cash flows generated for the quantitative criteria discussed are often difficult to forecast and hence rely on subjective input from project proponents.

Which takes us back to Keynes and Kalecki. Uncertainty and subjective sentiment are very important in the real world and attempts by the mainstream economists to simplify behaviour into asinine mathematical models which provide some semblance of certainty and perfect forward looking knowledge fail.

Further, in the mainstream models when risk is taken into account it is considered to be probabilistic, which defies the reality that the future can never be known in its completeness and so assigning probabilities to all possible future events is impossible.


Given the rigidity of the DCF models that firms around the world appear to use, which makes then insensitive to variations in interest rates, and the highly subjective nature of investment decision making, it is little wonder that firms are currently planning to cut back investment spending in 2016, despite record low interest rates.

The Government is telling the private sector that they are about cutting spending and thus cutting private incomes, which even those with the sparsest knowledge of economics can deduce will push up unemployment.

Households have record levels of indebtedness and consumption spending is moderating even with low interest rates, which are keeping many households solvent given their debt levels.

So, why would anyone invest in more productive capacity in that environment? The existing capital stock is capable of meeting current demand for goods and services and the risks of being burned if further capacity is built are very high indeed.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.

This Post Has 21 Comments

  1. But, there is much easier real world survey to be taken to find out also why firms do nott change discount rate when calculating hurdle rate. It isnt so much that firms expect low interest rate be only short term, it is that banks do not offer them rates as low as official rate.
    Bank rate can go down to 0 but banks do not follow that low in offering 0 rate to firms and households. Banks do not offer lower then 3,5%. No matter if the official rate is negative 9 banks will not transcribe that to what they offer to private sector, that would be only a rate for public sector.

    When i complained this to Ben Bernanke on his new blog, i rhink it was his third post about inefectivnes of monetary policy he did not wanted to publish it but in next post he admited that banks do not follow oofficial rate when they offer they rate to public claiming that the reason is increased risk of defaults in times of ZLB.
    Of course i wrote him again explaining that offering rates much above official rate is in itself the reason for such incresed risk of defaults, not some condition of the market. Too high real interest rates that bank offer to firms and household is in itselfe sole reason for defaults. Banks should be serving the purpose of offering negative interest rates to debtors and at the same time offer positive RIR to lenders. That is why they should print money qhen iasuing credit. That is why Positive Money proposals like 100% requiered reserves is bad proposal. Banks have to be able to offer negative RIR to borrowers (othrwise they will not borrow except for monopolistic investment where they can achieve high profits) and positive RIR to depositors at the same time.

    Today banks offer around 4% rate to boŕrowers which is too high above official rate and its also at positive RIR but excusing themselves by using official rate they offer only 1% to depositors qhich is close to neutral RIR. The spread is aginst borrowers big time. Should there be a question then of why firms do not change their expectations and hurdle rate even if discount rate went down?
    The real discount rate should be calculated using what banks offer them, not official rate, because firms do not get even close to official rate when borrowing in times of ZLB.

    Banks do not follow official rate bellow 3%, that is why developement banks that do offer 0 rate are a necessity in times of deppression and recession. It is the reason for a fairly recent attempt to set the target inflation at 4% not at 2% since banks do not go that low. Just a real world survey when i attemp to get a loan.

  2. Businesses invest when they are swamped with demand.

    It’s one of the first things I learned when I started doing business consulting is that the theory of financing isn’t what actually happens. The amount of justifying paperwork might increase as the firms get bigger, but the “Screw it, let’s do it” decision is always on gut feel – or often in a firm suffering from age induced entropy due to political pressure amongst the major players jostling for position and promotion.

    I still don’t understand why there is this love amongst economists for driving the vehicle by shifting the centre of gravity around when there is a perfectly good steering wheel directly connected to the wheels.

    Why try to cause indirect spending, when you can do direct spending?

  3. Neil asks why economists continue with their belief in interest rate adjustments. Partially it’s the fact that about 90% of the human race are robots: they’ll believe anything they’re taught.

    If today’s economists had been taught that GDP was related to the length of Bill Mitchell’s toe nails, they’d probably believe that too.

    One fundamental defect in interest rate adjustment is that it is DISTORTIONARY. That is, interest rate adjustments only influence households and firms with variable rate loans. In contrast, those with fixed rate loans, or little or no debt won’t be influenced by interest rate changes.

    I.e. interest rate changes make as much sense as doing a helicopter drop, but only on people with blonde and red hair, while those with different colour hair wait for the trickle down effect of spending sprees by blondes and red-heads.

    However I wouldn’t totally ban interest rate adjustments: obviously they’re a useful tool for governments / central banks to use in emergencies.

    Two other studies which pour cold water on interest rate adjustments:



  4. I can only speak from own experience, however, that experience has demonstrated to me, that the following is generally the case.

    Businesses invest for a variety of real world reasons.

    Some as pedestrian as a CEO who wants to fill white space in a five year plan. Others do it for public notoriety or to support stock prices. Of course there are other times when businesses invest because their customers force them to, certainly more prevalent in the business to business supply chain.

    The internal hurdle rate is pretty much standard for project evaluation in my experience, although, that in itself is never a show-stopper. Many a project has been made to look fabulous because certain executives and interested parties have vested interests.

    Qualitative reasons often supersede financial reasons.

  5. Jordan Croatia,

    There’s a good reason why the rate charged by commercial banks is always significantly above the central bank base rate: risks and administration costs are involved in lending to the typical customers of commercial banks (i.e. small firms, individual mortgagors, etc). E.g. some of those borrowers (small firms in particular) go bust and don’t repay what they’ve borrowed.

    Second, and re your claim that benefits would derive from commercial banks lending at a zero rate, I’m afraid I agree with Bill Mitchell and Neil Wilson there, namely that interest rate changes have little effect. I.e. your zero rate would not achieve much.

    In the words of Jamie Galbraith, “firms borrow when they can make money and not because interest rates are low.”

  6. No business will invest – no matter the calculated NPV and irrespective of interest rate – unless there is obvious continuing future excess demand for their product.

    Even at a zero interest rate, unless there is demand there is absolutely no point in investing.

    No need for economic theory 🙂

  7. Ralph
    I am looking at it more long term since monetary policy works primarily medium term finding an equilibrium. By admission of governors rate change takes a full effect in about a year, that is short to medium term and in normal times.

    And the rate that commercial banks charge is not always significantly higher then official rate. Last 20 years before GFC the spread was really low, around 100points. Why is 300 points today?
    How that ‘risk’ came about? Risk of defaults in debt economy comes mostly from decreasing lending. Slowdown in lending reduces liquidity and increse defaults. That is Minsky’s point.
    Banks themselves create higher risk by reduction in lending or when borrowers find it above their income ability.

    Why firms do not find investment opportunities today? Because consumers find loans too high rate for their income so they can not supplement their buying power with loans as they used to. Spread or positive RIR is too high.

    Can you see feedback loop here? Banks increase defaults by high rate charge and then claim the risk as the reson for high rate they charge.

  8. Another feedback loop is connection between investment levels and demand for more investment(production). By cutting on investments firms lower the demand for their goods, cause their spending is somene elses income to buy more of their production.

  9. Blogs like these make me happy I do a proper job and never wasted my time
    learning models of imaginary worlds guided by invisible hands.
    Beware of all levers , mechanisms and self correcting systems.Remember
    even evolution fails leaving its inevitable history of extinction.

  10. “Why investment expenditure is insensitive to monetary policy”

    It isn’t according to M.M.T. – Market Monetarist Theory!

    It targets nominal G.D.P. and assumes! that the target can be hit by the use of ‘Forward Guidance’ and open market operations!

    Of course, if the targets aren’t hit, then there was insufficient ‘Forward Guidance’ or O.M.O.?

    “Japan did many years of fiscal stimulus and QE, and still had a hard time figuring out how much QE to do, and ended up doing the wrong amount.”!

  11. “Capital is not a piece of putty”

    Furthermore it certainly is not putty in a modern economy for a while.
    For example manufacturing does no scale as the neoclassical theory envisions it: that is to say they still believe production is like a farm and field adding or removing manual labour/tractors until a perfect level of production/cost is achieved.

    The last 200 years of modern industry is specific level of built in excess capacity and level of efficiency AT EACH level of capacity is highly efficient with regard to human labour and machine labour. So output is quanta/discreet output not agricultural in essence. You either go and build a whole motherboard factory or you dont.
    This is one of those real world observations that knocks the ‘curves’ on the head: ‘demand’ curve and ‘marginal cost’ curve specifically.

  12. Of course if it was a state bank doing the lending then the interest rate on those
    loans would be a tax .A tax which could be raised and lowered with the economic
    cycle.If it was a state bank which offered inflation proof pension savings then the volume
    of pension bonds available each month could rise and fall with the economic cycle.

  13. Hi there!

    I’ve been lurking in the shadows for a while, gradually getting my head round all this but I can instinctively tell that this blog speaks the truth and that practically everything the average person thinks they know about economics is nonsense.

    I just have a few quick questions which I would be thankful for an answer to from anyone out there:

    1) In Europe much is made of the fact that high tax countries like Denmark have far better public services than lower tax ones like the UK (both not part of the Euro). How does this compute with the MMT message that taxes are simply used to regulate demand and are not required to invest in public infrastructure etc.?

    2) At a non Federal level, does it make sense for a government to talk about raising taxes to pay for something? For example the State of California cannot print dollars. Therefore if the State wants to increase welfare or build a bridge, would it make sense at this level to raise taxes to pay for it and to be worried about a deficit?

    3) With regard to the IMF bailing out countries, is it true to say that all the IMF does is print e-money and lend it at interest to impoverished nations? The common perception is that the IMF loans tax payer money, am I right in saying this is obviously nonsense?

    Many thanks, I’m still fighting my way through the history of the blog


  14. Interesting blog post,learnt about DFC which is probably what chartered financial accountants look at.(of which I am not one)

    What I do get is that firm will invest when they feel that cash flow will pay off the borrowing costs comfortably as well as operating costs,and a sufficient tidy profit for the firm.

    And as the blog has spelled out,if the real demand is not there,despire Central Bank interest rate being historically low,they will not invest.

    Government should not be reducing spending,as that will reduce private sector spending.Household indebtedness is also discouraging spending,and therefore aggregate demand.No one is going to expand the productive capacity of the economy if Demand isn’t also expanding.

    All this is calling out for a fiscally active government to spend sufficiently to generate demand,boost income which actually encourage business lending/investment.

    But,nonetheless these historically low interest rates have been having an effect around the world.In all western nations asset price inflation has gone through the roof.Equities,headline grabbing tech stocks,City centre property with multimillion price tags.Property in general is going up(yes gov subsidies have also helped).But collectors items and fine art have gone up.
    For a certain section of society these historically low interest rates have had the desired stimulating effects.

    I have a lot of sympathy with what Jordan Croatia is saying,Banks are not passing on these reduced rates to consumers/households or firms.Hedge funds /banks other financial actors who have access to the money markets and can borrow at the
    Central bank rate can borrow and inflate non-productive mostly price inelastic assets to soaring new levels.
    Banks have simply absorbed the increased margin leeway given to them by Central Bank rates and hogged it as profit,when dealing with Households and firms.Which might be why firms have not altered their dfc/nvp models because at the retail level the discount/hurdle rate has not changed.
    Lending risk compensation in adverse economic climate?Not sure I buy it,yes we need fiscal intervention.But the other side of the coin must be giving or passing on too firms and Households a greater margin,so even if incomes/cash flow is sluggish,they only have to devote less of it to borrowing cost.You can increase cash flow and therefore firm strength,not just through increasing income but also through decreasing costs(borrowing costs).

    Why is their one type of cost structure (300 basis points to mitigate against risk and admin costs) for one type of lending (productive real economy)and another cost structure(small neglible mark up for potentional bubbles and busts) for a different type of lending(asset speculation)
    Why is the risk of lending in the real productive economy so much higher than lending to financial actors for asset speculation.
    What is the justification…tight margins lead to default,so decrease costs and protect the margin for firms’ financial stability sake.Price inflation and the increased activity in the financial sector(bankers are doing okay) demonstrates that low interest rate environment has had a stimulating effect.Contrasting with lending in the high interest rate real productive economy.

    We need fiscal activism to support demand but we also need public facility for lending to pass on those low margins to households and firms,to protect a reasonable cash flow for firms and comfortable operating margins and reduce the risk of non-performing capital investment,which generates loss of income Which further decreases lending,and the downward part of the Minsky cycle.
    We need to get money and activity into the real economy,through the right plumbing,we need the right infrastructure for it.

    Meanwhile on the other side of the Interest rate wall/Apartheid (to quote a firebrand TV personality)The asset price inflation caused by financial actors is reducing disposable incomes for households.which isn’t leaving the economy,but it isn’t be spent on consumption either,which disinhibits demand and therefore any motivation to invest and expand the productive capacity of the economy.

    Yes income devoted towards borrowing costs and rents stay in the economy,but they tend to get tied up in assest or savings of the superich,in other word it gets stuck in stock.We need money moving around at high velocity in consumption and investment or in other words in flow.When people have more of their income,(greater proportion) to spend on consumption or firms have more to spend on wages/further investment/buffer capital as opposed to simply having more income then more money flows through the productive important part of the economy.This increases demand and supports employment and higher wages and better living standards.The part which employs more people and makes useful things that people need.

  15. because at the retail level the discount hurdle level has not changed.*-I don’t know I would have to look at the studies reffered to in the article regarding prices sensitivity.

    I notice the article, finishes by broadly commenting that interest rates changes affect cash flows.

  16. Barzini,

    1) if you spend 20% GDP on services as opposed to 10% you risk adding so much to aggregate demand as to hire all available resources and more, so you risk inflation. So you also need higher taxes. They do not pay for the spending per se, but they do need to be higher to regulate the demand.

    The aspect of getting the population to use the currency at all does not differ between these two levels of spending.

    2) yes, like a household or a firm a US state can go bankrupt and its taxes pay for its spending. It can’t regulate interest rates it pays on its own debt, unlike tha federal govt which indirectly does that by seti g the short rate via its agent, the Fed.

    3) i don’t know. It could be that IMF itself gets funds from member govts who create the money ex nihilo and the IMF only directs it. I doubt the IMF can create on its own, but the result is the same – the “borrowers” get funds created out of thin air by someone.

  17. Jake what you are describing is a dysfunctional banking sector.Dysfunctional
    for the needs of society as a whole .Making enormous amount of money in
    the short term by speculating on future price of existing assets whilst there is
    little money to be made by agreeing loans for the production of new stuff.
    Yes we need fiscal stimulus from governments to make investment profitable
    we also need vital investment from government but we would still be left with
    a dysfunctional banking sector.
    I think we need state banking and I do not think that means nationalization.
    It does mean the state not bailing out banks .

  18. “Why investment expenditure is insensitive to monetary policy”

    “The source of financing most correlated with investment is long term debt. The correlation between I and dLTD is 0.79… These correlations confirm the impression … that debt plays a key role in accommodating year-by-year variation in investment.”
    (Eugene F. Fama and Kenneth R. French, 1999, p. 1954)

  19. @Kevin Harding,you agree that the status quo is dysfunctional.
    Are you saying we should allow banks to fail whilst simultaneously setting up public banks to move into business lending at low rates?

  20. jake yes I am saying there should be a state banking sector set up ,not
    nationalizing or bailing out existing banks.As to the criteria for loans and the
    rates charged above all they would have to be transparent corruption is the risk.
    I think the state via its bank or not should offer inflation proof pension bonds too
    a maximum amount every month varying with the cycle to en/discourage savings.
    Ideally fiscal policy would provide plenty of savings to households.

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