RDP 2018-05: Do Interest Rates Affect Business Investment? Evidence from Australian Company-level Data 5. Conclusion

Investment and the cost of debt are very heterogeneous across companies; at any point in time, some companies are investing while others are not. And, for those that are investing, they all face different interest rates. This paper highlights the importance of accounting for this heterogeneity when analysing the relationship between the cost of finance and investment. We document that the interest rates faced by some companies have remained relatively high in recent years. Moreover, we show that there is a significant negative relationship between company-specific interest rates and their investment, a relationship which is hard to establish with aggregate time-series data.

These findings have important implications for monetary policy. In particular, the low level of both the cash rate and average business lending rates may not have translated to lower borrowing rates for all companies. This may help to explain some of the weakness in non-mining business investment in recent years.

There are a few caveats to our analysis. First, it is unclear whether our results generalise beyond a sample of listed companies with debt to the broader corporate population. Multiple imputation techniques suggest that the relationship may be weaker for companies without debt and that other studies fail to properly account for sample selection when focusing purely on firms with debt.

Second, our results do not establish why there is a link between interest rates and investment as we do not isolate a plausibly exogenous source of variation in interest rates. The negative relationship between interest rates and investment does not appear to reflect changes in monetary policy, at least not directly, as we control for aggregate fluctuations in the analysis. The relationship is also not due to variation in company risk, as this is controlled for through various indicators such as the distance to default. Instead, we argue that it may be due to credit supply effects. A relaxation of lending standards leads to lower interest rates (for a given company profile), which encourages more investment.