One of the great mysteries of the recovery is why low interest rates have done so little to lift business investment.
After all, that is supposed to be one of the ways monetary policy works: A lower cost of capital makes any project more viable. But what if lower interest rates are actually hurting investment by encouraging companies to pay dividends or buy back stock instead?
That’s the theory advanced by economist Jason Thomas of private-equity giant Carlyle Group. CG 1.06 % It is at odds with conventional economics but has some intuitively appealing logic and supportive data.
He calculates that since 2009, just after the Federal Reserve took interest rates to near zero, U.S. companies have boosted stock buybacks by 194% and dividends by 66.5%, but investment by 43%. Big energy companies have been slashing capital expenditures while boosting payouts. Even companies without the headwind of lower commodity prices are holding the line: McDonald’s Corp. MCD 0.54 % and Eli Lilly LLY -0.37 % & Co. are maintaining flat capital expenditures while raising dividends; Verizon Communications VZ -0.41 % Inc. said it plans to trim its capital budget and has raised its dividend....
Mr. Thomas may have solved part of the puzzle of low investment, but not the entire puzzle. He has found that low interest rates boost the performance of stocks that pay high dividends but hasn’t shown that dynamic influences companies’ investment decisions. While dividend considerations might give companies one reason not to invest more when interest rates are low, it isn’t clear how important that effect is in the scheme of things. A company may see few promising capital projects and thus conclude it would rather return the cash to shareholders. This wouldn’t be because interest rates are low. It would be reflecting the same forces that are keeping rates low—too much cash chasing too few profitable investments.
Countless other factors affect the decision to invest, the most important being the outlook for sales, which tends to benefit from low interest rates which boost consumer spending. Higher interest rates would damp consumer spending and push up the dollar, both of which would hurt sales and thus investment. Moreover, for companies that don’t have publicly traded shares or pay high dividends, the traditional benefit of low rates on investment is probably still more important than the effect on the share price.