The IMF on Investment since 2008

Vox today has a useful piece by five IMF economists on the behavior of business investment during and since the Great Recession. [1] From my point of view, there are three important points here.

1. The most important difference between this cycle and previous ones is the larger fall and slower recovery of private investment. This has always been my view, and I think it's an especially important point for heterodox folks to take on board because there has been such (excessive, in my opinion) emphasis on the inequality-consumption link in explaining persistent demand weakness.

This relationship between output and investment is consistent with previous recessions: 

business investment has deviated little from what could be expected given the weakness in economic activity. In other words, firms have reacted to weak sales – both current and prospective – by reducing capital spending. Indeed, in surveys, businesses typically report lack of customer demand as the dominant challenge they face.

In other words, the old Keynesian "accelerator" story explains the bulk of the shortfall in investment since 2008.

2. Historically, deviations in output and investment has been persistent; there is no tendency for recessions to be followed by a return to the previous trend. 

The blue line shows the behavior of output and investment in recessions historically, relative to the pre-recession trend. Note that is no tendency for the gap to close, as much as six years after the previous peak.

The authors don't emphasize this point, but it is important. If we look at recessions across a range of industrialized countries, on average the output losses are permanent. There is no tendency for output to return to the pre-trend. If this is true, there's no basis for the conventional distinction between a demand-determined "short run" and a supply-determined "long run." There is just one dynamic process. Steve Fazzari has reached this same conclusion, as I've written about here. Roger Farmer has just posted an econometric demonstration that in the postwar US, output changes are persistent -- there is no tendency to return to a trend.

 3. There's no reason to think that the investment deficit is explained by financial constraints. I should say frankly that the paper didn't move my priors much at all on this point, but it's still interesting that that's what it says. By their estimates, firms in more "financially-dependent" sectors (this is a standard technique, but whatever) initially reduced investment more than firms in less financially-dependent sectors, but as of 2013 investment in both groups of firms were the same 40 percent below the pre-crisis trend. If you believe these results -- and again, I don't put much weight on them, except as an indicator of the IMF flavor of received opinion -- then while tighter credit may have helped trigger the crisis, it cannot explain the persistent weakness of demand. Or from a policy perspective -- and the authors do say this -- measures to improve access to credit are unlikely to achieve much, at least relative to measures to boost demand.

Investment by sector

So these are features it might be nice to incorporate into a macro model -- investment determined mainly by (changes in) current output; a single system of demand-based dynamics, as opposed to a short-run demand story and a long-run supply-based steady state growth path; a possibility of multiple equilibria, such that (let's say) a temporary interruption of credit flows can produce a persistent reduction in output.  On one level I don't especially trust these results. But on another level, I think they provide a good set of stylized facts that macro models should aspire to parsimoniously explain. 

[1] The European Vox, not the Klein-Yglesias one.


UPDATE: Krugman today points to the same work and also interprets it as support for an accelerator story.