THE IMPACT ON INDUSTRIAL FIRM INVESTMENT SPENDING BY THE FEDERAL RESERVE’S MOVE TOWARD NORMALCY IN U.S. MONETARY POLICY 2013-2018

Abstract

The U.S. Federal Reserve (Fed) acted in an unprecedented fashion to drive interest rates aggressively and creatively to the zero lower bound (ZLB) and employed other unconventional monetary policy (UMP) tools to provide stimulus to the U.S. economy during the financial crisis and the subsequent extended recovery period. However, despite these innovative policy tools, the U.S. economy realized a historically weak recovery. The unconventional monetary policy tools, including the expansion of the Federal Reserve’s balance sheet by purchasing longer dated securities, paying interest on reserves, and providing forward guidance, structurally changed the conduct and implementation of monetary policy from the post-WWII experience. Significant research has been developed that describes and analyzes the impact and effectiveness of this experiment in using unconventional monetary policy tools to stimulate the economy. However, very little research has been conducted that studies the response of various economic actors to the Fed’s reversal of these emergency measures as it sought to rein in a potentially overheated economy or counter incipient inflation. When the Fed methodically raised interest rates from 2015 until the end of 2018 investment spending, as indicated by private nonresidential investment spending, did not slow as expected according to mainstream economics or as evident in prior periods of monetary tightening. This anomaly should also be evident in measures at the firm level as firm investment outlays comprise the bulk of the GDP reported private nonresidential investment spending. This research study determined that firm level investment spending, as represented by the growth of total assets, did not respond negatively to the Federal Reserve’s actions that raised interest rates. Other factors such as the general improvement in GDP growth, improved business confidence in the national economy, and greater optimism of near-term firm prospects explain to a far greater degree the growth in total assets compared to Fed activity. Effectively, factors contributing to improved business confidence overwhelmed the Federal Reserve’s intention to slow investment growth by raising interest rates. This research supports the Bernanke et al. (2019) proposal and Hebden and López-Salido’s (2018) research that indicate a stimulative monetary policy when rates are constrained by the effective lower bound and characterized by a lower for longer (L4L) monetary posture results in better output and inflation outcomes. Further, this research offers empirical evidence of Bernanke’s caution that although L4L results in better outcomes, there is a potential for output and/or inflation overshoot forcing the Federal Reserve to abruptly reverse policy stance, a scenario played out by the Federal Reserve soon after it stopped tightening at the end of 2018. The results here expand the work completed by Khan and Upadhayaya (2018), and Konstantinou and Tagkalakis (2011) that business confidence has a significant influence on business investment spending by analyzing the response of business decision makers during an unprecedented time as the Federal Reserve removed emergency measures and turned to a tightening regime.