Finance and Economics Discussion Series (FEDS)
January 2014 (Revised September 2015)
Why isn't Investment More Sensitive to Interest Rates: Evidence from Surveys
A fundamental tenet of traditional theories of investment and monetary policy transmission is that interest rates are a critical determinant of business investment expenditures. Yet, a large body of empirical research offers mixed evidence, at best, for substantial interest-rate effects on investment. We examine the sensitivity of investment plans to interest rates based on surveys of CFOs during the recent economic recovery. We find that most firms claim their investment plans to be quite insensitive to decreases in interest rates, and only somewhat more responsive to interest rate increases. CFOs most frequently cited either ample cash or the low level of interest rates as reasons for lack of sensitivity. In the cross-section, we find that insensitivity to interest rate changes tends to be most pronounced among firms that do not indicate financial constraints as a top concern and firms with no near-term plans to borrow. Perhaps more surprisingly, investment is also less interest-rate sensitive at firms expecting higher year-ahead growth. These findings appear to be consistent with survey data on the "hurdle rates" firms report using to make new investments decisions: the average reported hurdle rate has hovered near 15 percent for decades, despite the downward trend in market interest rates. Moreover, firms expecting to grow more tend to have higher hurdle rates, suggesting a possible connection between interest rate insensitivity and high hurdle rates.
Keywords: Investment, interest rates, hurdle rates
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