October 29, 2015
A NYT article on the prospects of an interest rate hike by the Federal Reserve Board at its December meeting told readers:
“The case for raising rates hinges in part on the Fed’s forecast that the economy will continue to add jobs at a healthy pace and that inflation will begin to rise more quickly. Moreover, some analysts argue that maintaining near-zero interest rates is now doing more harm than good by encouraging businesses to invest in things like share buybacks to lift their stock price, rather than long-term investments in equipment and developing new products.”
It’s difficult to see how low interest rates would cause firms to prefer share buybacks to long-term investment. Low interest rates make the cost of borrowing lower. This could lead some firms to carry more debt and use cash for share buybacks or dividends. But low interest rates also make it easier to borrow for long-term investment. There is no obvious mechanism through which low interest rates would lead firms to divert money from investment to share buybacks.
If low interest rates eventually led to enough growth that it pushed up the rate of inflation, then they could provide a boost to investment at the expense of buybacks (higher inflation means that the output will sell for more, raising profits, other things equal). It is difficult to see how low interest rates could cause buybacks to increase at the expense of investment.
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