Low Interest Rates, Market Power, and Productivity Growth
- Date Posted:
- Is Database:
- Database
Low interest rates reduce business dynamism as market leaders gain share, while market followers cut investment to a greater degree than they do in the face of low rates.
"...The focus of this paper is on understanding how the production side of the economy responds to a reduction in long-term interest rates driven by consumer-side forces. The existing literature in growth either assumes no production-side response to declining interest rates, or a positive response driven by an increased incentive to invest in the face of a higher discounted present value of future profits. The point of departure from this literature lies in explicitly modeling competition within an industry and analyzing how lower interest rates effect the nature of competition. The model builds on the dynamic contests literature to show that in a fairly general set up and without relying on any financial or other forms of frictions, the effect of lower interest rates on growth in a low interest rate regime can be negative. A reduction in long-term interest rates tends to make market structure less competitive within an industry. The reason is that while both the leader and follower within an industry increase their investment in response to a reduction in interest rates, the increase in investment is always stronger for the leader. As a result, the gap between the leader and follower increases as interest rates decline, making an industry less competitive and more concentrated. When interest rates are already low, this negative effect of lower interest rates on industry competition tends to lower growth and overwhelms the traditional positive effect of lower interest rates on growth. This produces a hump-shaped inverted-U production-side relationship between growth and interest rates.The model delivers a distinctive upward sloping production-side curve in a low interest rate regime. We believe that this insight is empirically relevant and useful in understanding the slow-down in productivity growth in recent decades and the broader discussion regarding “secular stagnation.” The slowdown in productivity growth is global as it shows up in almost all advanced economies. The slowdown started well before the Great Recession, suggesting that cyclical forces related to the crisis are unlikely to be the trigger. And the slowdown in productivity is highly persistent, lasting well over a decade. The long-run pattern suggests that explanations relying on price stickiness or the zero lower bound on nominal interest rates are unlikely to be the complete explanation. This paper introduces the possibility of low interest rates as the common global “factor” that drives the slowdown in productivity growth. The mechanism that the theory postulates delivers a number of important predictions that are supported by empirical evidence. A reduction in long term interest rates increases market concentration and market power in the model. A fall in the interest rate also makes industry leadership and monopoly power more persistent. There is empirical support for these predictions in the data, both in aggregate time series as well as in firm-level panel data sets...."
Ernest Liu, Atif Mian and Amir Sufi, "Low Interest Rates, Market Power, and Productivity Growth," Social Science Research Network, February 4, 2019, https://papers.ssrn.com/sol3/papers.cfm