Investment and Profits after the Great Recession

Abstract

Investment since the Great Recession has been lackluster while some measures of returns on capital and valuations measured by Tobin's Q were high, and while policy interest rates were low. In this paper, we shed light on this puzzle by arguing that weak profits have dampened investment in the post-Great Recession environment. At the heart of our argument is the thesis that profits drive investment. We provide novel empirical evidence for this thesis using Toda-Yamamoto augmented Granger causality tests. We also explore the mechanisms whereby profits could drive investment. We argue that profits, the driver of investment, have been low in the post-Great Recession environment. To reconcile this position with the high and stable level of some measures of returns on capital and with high valuations implied by Tobin's Q we emphasize the diversity of weakly correlated profits measures and argue that measures of profitability less reliant on stock market valuations should be used to explain investment dynamics given stock price distortions. This account overcomes some limitations of secular stagnation theories. We further argue that low investment has persisted despite expansionary monetary policies because recent macroeconomic developments have dampened these policies' effectiveness and investment's responsiveness to interest rates.

Keywords: monetary policies, quantitative easing, investment dynamics, profits, secular stagnation, weak investment, Tobin’s Q

JEL Classification: E40, E50, E52, E58, E60