Business investment spending represents spending by businesses on new plants, fa

Question

Business investment spending represents spending by businesses on new plants, factories, equipment, technologies, etc. According to economic theory, the primary determinant of the level of business investment spending is the level of real interest rates. The Federal Reserve in 2008 reduced interest rates effectively to zero. Business investment spending, however, collapsed, declining as much as 25% annually over the next two years. How would you resolve this seeming paradox of rock-bottom interest rates and a collapse in business investment spending? Please briefly explain.

Explanation / Answer

INTEREST RATES ARE DRIVING FORCE WHICH BRINGS IN THE SAVINGS. THESE SAVINGS IN TURN ARE DIVERTED TOWARDS INVESTMENTS. INVESTMENTS ARE REQUIRED TO ESTABLISH NEW FACTORIES, BUSINESSES AND FACTORIES. THE NEW BUSINESS MEANS MORE INCOME FOR THE PEOPLE AND GROWTH IN THE ECONOMY. THIS GROWTH ENTAILS MORE SAVINGS AND MORE SPENDING. AGAIN THE SAME STEPS ARE FOLLOWED AND THE ECONOMY KEEPS ON GROWING. HOWEVER IF THE INTEREST AE SLASHED THE MONEY BECOMES MORE DEAR TO THE PEOPLE AND THEY PREFER TO USE IT AND DOES NOT WANT TO SAVE IT, THE RESULT IS NO MONEY AVAILABLE FOR INVESTMENT. THIS SHORTAGE OF MONEY FOR INVESTMENT AND EXTRA SPENDING CREATES A SHORTAGE FOR THE GOODS IN THE MARKET AND THE BUSINESS CANNOT INCREASE THE CAPACITIES. THIS SHORTAGE OF SAVINGS MADE THE ECONOMY GO SLOW IN 2008. THE RESULT WAS A FALL IN BUSINESS INVESTMENT COMBINED WITH RECESSION WHICH RESULTED IN THE COLLAPSE.

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