I recently followed MIT online lectures for economy and I found this - one of the reason for investments decline in recession is bad expectations about economy -----> leading to Higher capital output ratio -------> lower Investments

How does bad expectations leads to higher capital output ratio and then why does that translates into low investments? My thoughts - Bad expectations about economy might cause firms to severely cut their production. Since, output gets lower and output being in the denominator makes the whole fraction to be bigger so we get higher capital output ratio and that discourages investments because cost of capital is high so with the lower output it would be hard to pay off the loans. Is my reasoning correct? Is it conceptually sound? Am I thinking clearly and simple yet effectively? I am not sure about the answer neither with my line of reasoning.

You're welcome to critique my thoughts and lead me to correct answer or you can share your own views or answer about it (and I guess that would be way better and conceptually sound)

Thank you so much for your time. Grateful!

  • $\begingroup$ Hi. Welcome to the site. Could you provide a link to the lectures that you are referring to? $\endgroup$ – jmbejara Sep 9 at 21:37
  • $\begingroup$ Also, it sounds like you're describing the basic intuition behind Q theory of investment. Romer's book "Advanced Macroeconomics" gives a good description. $\endgroup$ – jmbejara Sep 9 at 21:41
  • $\begingroup$ I am not an expert here. But I believe the idea is that investors see no need to increase investments since the amount of "perceived" investments is already high, relative to the quantity of of outputs (goods or services produced). They would think that even if they were to raise the quantity of investments, that would be excessive and would not necessarily lead to greater output. Hence, the level of investments stagnates. Just my thoughts $\endgroup$ – Tan Yong Boon Sep 12 at 0:50

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