I've heard an interview with Bill Gross in which he claims that one of the problems with lower interest rate is that it leads to a lower return on investment (ROI) in the real economy.
How can that be?
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1$\begingroup$ I can't say for Bill Gross for sure, but perhaps he meant that when money is cheap ("zero interest rate"), an investor's money is cheap too, so this investor earns less. That is, the cost of capital (ROI) is low. $\endgroup$– Anton TarasenkoCommented Jan 19, 2015 at 11:24
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3 Answers
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Cheap money makes it worthwhile doing stupid things.
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$\begingroup$ I understand why someone might have downvoted this, but it does give a (good?) answer. I'm sure this could be argued or elaborated on, but I'm going to upvote it because it's an answer I've heard before. $\endgroup$– jmbejaraCommented Feb 12, 2015 at 9:06
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1$\begingroup$ @jmbejara Yes, and I think it's not a nice answer because exactly the lack of elaboration. It sufficient to be posted, I guess, so I can't report it - but I don't like it either in its current state. $\endgroup$– FooBarCommented Dec 3, 2015 at 14:34
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It might have to do with the real rate of return. It comes down to the assumption that return on investment is the sum if inflation, say 3%, and the actual return of the project (say 5%). This would total to 8%. If inflation would go down to 1%, the total would drop to 6%. Any additions and/or corrections are welcome.
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Let's accept the Fisher equation,
$$r = i-\pi$$
where $r$ is the real interest rate, $i$ is the nominal interest rate, and $\pi$ is inflation.
Let's also accept that the the real interest rate earned on financial capital is the same or co-moves with the ROI, the rate of return on investments in non-financial capital (i.e. in physical and human capital, and or in technology, etc). This we accept at least as a tendency, due to the possibility of arbitrage considerations, if it was otherwise. So let's say
$${\rm Corr}(\text{ROI}, r) = {\rm Corr}(\text{ROI}, i-\pi) \approx 1$$
But the above relation expresses association and co-movement, not causality.
Then, the statement in question, implies that causality may also run from nominal interest rates to the $\text {ROI}$.
With stable inflation, lower nominal interest rates imply lower real interest rates. No effect on $\text {ROI}$ yet. Lower real interest rates will presumably push the holders of funds out of financial capital investment and relatively more into direct investments, for which they will be ok if the $ROI$ is lower than previously, as long as it does not fall below the new lower real interest rate on financial assets.
This is a way to rationalize the statement.
answered Dec 3, 2015 at 15:28