One of the charts I prepared for my presentation at the G30 was intended to debunk the notion that we need some kind of special factor aside from the depressed economy to explain low business investment. On the x-axis of the figure below I show the ratio of actual GDP to the CBO estimate of potential GDP. On the vertical axis I show the ratio of nonresidential fixed investment ? basically, business investment ? to potential GDP. The blue dots show data from 1985 to 2007, during which there was a strong relationship: a depressed economy led to low business investment. The red dots show subsequent data; if anything, business investment has been stronger since the Great Recession began than you might have expected.
To pre-answer one possible objection, yes, the relationship is much weaker before 1985. I?d argue that this reflects the changed nature of the business cycle, which I?ve been writing about for years. Pre-1985, recessions were basically generated by the Fed to curb inflation; since the Fed could and would relax the reins as soon as it judged that we had suffered enough, deep recessions tended to be followed byrapid V-shaped recoveries, so it made sense for businesses to keep investing even in the face of a depressed economy. Subsequent recessions have reflected private-sector overreach, and have therefore tended to be followed by slower recoveries, giving businesses a good reason to postpone or cancel investments.
Also, no, the causation doesn?t run the other way, at least not in general. The Great Recession, in particular, was led by housing and consumption, with business investment clearly responding rather than leading.
Source: http://krugman.blogs.nytimes.com/2011/12/03/explaining-business-investment/
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