Working Paper: NBER ID: w10354
Authors: Raj Chetty
Abstract: This paper studies the effect of interest rates on investment in an environment where firms make irreversible investments and learn over time. In this setting, changes in the interest rate affect both the cost of capital and the cost of delaying investment. These two forces combine to generate an aggregate investment demand curve that is always a backward-bending function of the interest rate. At low rates, increasing the interest rate stimulates investment by raising the cost of delay. Existing evidence supports the hypothesis that firms change the time at which they invest in response to changes in interest rates. The model also generates a rich set of additional predictions that can be tested empirically.
Keywords: No keywords provided
JEL Codes: D83; D92; E22; E52; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in interest rates (E43) | Reduction in the set of profitable investment projects (G31) |
| Increase in interest rates (E43) | Incentivization to invest sooner (G11) |
| Incentivization to invest sooner (G11) | Increase in investment (E22) |
| Increase in interest rates (E43) | Increase in investment in sectors with high learning potential (J24) |
| Investment demand curve (E22) | Nonmonotonic relationship between interest rates and investment (E43) |
| Changes in interest rates (E43) | Effects on cost of capital and cost of delaying investment (G31) |