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I'm sorry but that seems to go again the currently admitted way the IS/LM model works http://en.wikipedia.org/wiki/IS/LM_model http://en.wikipedia.org/wiki/IS/L

• 001sky 14y ago
  I might be wrong - I'm quite new to macroeconomics IS/LM and is not something that I would hang my hat on, here.[1] The reason is that the performance evelope of the firm must be considered micro-analytically. Ie, you need to take the perspective of the firm as a composite of capital investment projects. The aggregate value of the projects will be the value of the firm. What impacts the decisionmaking of the firm? The spread between the cost of capital and the return on capital. For a fixed opportunity set of projects, a lower cost of capital will result in incremental investment provided that capital is available and capital projects are available that exceed the cost of capital. How does one get these projects? In the real world, these are "hunted" like big game. These projects are either invented by engineering (new widget X) or they are extensions of current product (widget Y) that are sold to new clients (Z) by sales or bus dev. Internally, the "green light" for these hunting parties is a hurdle rate (set to an average expected return-average cost of capital=some threshold level). Because there is uncertainty[2] in these big-game hunting expeditions, over time they will converge to the least amount of work necessary to clear the threshold. So, by this logic, the quality of projects will decrease over time as the threshold of project quality declines. On the other hand, the external environment will also drive down this potential. Other companies will be increasing their hunting parties, increasing competition and reducing the probability of success. The combination of these two factors, will over time decrease the performance envelope of the hunter/gatherer parties (be they engineers or sales/bus-dev). The issue is that this decline may have persistent effects (ie, learning by doing cuts both ways.) ________________ [1] See my footnote earlier. The IS/LM model assumptions and general methodology will not capture the recursive and inter-temporal effects on the opportunity set of projects that will follow from interest rates approaching zero artificially (ie, by fiat stimulus). [2] And not insignificant cost.
  • guylhem 14y ago
    Very interesting. The "innovation" during low interest rate periods would still happen, but as you say would be a lesser kind of innovation, and with lasting persistent effects. This could explain the current divergence in the GDP per capita curve (usually log linear) if we follow the idea that a continuous pace of innovation is necessary. A quick wolframalpha graphing of the GDP per capita curve and federal funds rate shows in fact that the GDP per capita curve has inflections when interest rate quickly fall or go below 2.5%. But considering that interest rates are used by the fed to try and fix the economy and thus highly correlated with high and lows, I don't know if there is a good way to check for this hypothesis. It could also have bad consequences, since it predicts that countries with low interest rate (currently EU, US, JP) will experience a lesser form of innovation with lasting effects - and unfortunately I don't see interest rates going up, not with the current focus on low inflation. It still is a very interesting concept. I would like to know more. Is there a name for the model you are describing? (or some links)