The Fed Doesn't Know What Corporate America Needs

NEW YORK (TheStreet) -- When conventional monetary medicine becomes ineffective, central banks often resort to a dose of quantitative easing (QE) to stimulate the economy. The Federal Open Market Committee (FOMC), a group within the Federal Reserve, will likely agree to another round of QE in one of its next two meetings. But would it work?

Last month's Duke-CFO survey of 450 U.S. CFOs drilled down to the key driver of growth: investment. We find new evidence suggesting that small tweaks in the interest rate would not have a measurable impact on investment.

While consumer spending represents two-thirds of GDP, the key driver of growth is private investment. Consumer expenditures are smooth. For example, in the horrible first quarter of 2009, real consumer expenditures dropped by 1.6% (annualized). In contrast, gross private domestic investment plunged by 43% (also annualized).

The Fed's main levers are interest rates. The short-term rate is already essentially zero. It is unlikely that the Fed would push the short-term rates below zero. Long-term rates are more difficult to control, but at the last FOMC meeting, the Fed extended its Operation Twist by agreeing to spend $267 billion to buy long-term bonds (to reduce yields and borrowing costs) and finance it by selling shorter-term bills.

There are other options. They might include lowering the 0.25% interest rate the Fed pays banks on reserves to prod them to lend money rather than park it with the Fed. It is possible to purchase other (non-government bonds) assets (in an indirect way), which might lower interest rates on corporate bonds. They might even copy the Bank of England's scheme to subsidize bank lending. But the common logic is that, by reducing the cost of borrowing, investment will increase.

While this logic seems sound, there are at least two reasons why investment will not robustly respond to QE given today's circumstances.

First, the cost of borrowing is already amazingly low. The yield on Moody's Baa rated bonds is only 4.8%. The yield on the highest-grade bonds, Aaa, is only 3.3%. These rates are rock bottom -- we haven't seen levels like this in 50 years. Yet investment has not responded.

It is unlikely that lowering the interest rate a little more will produce any measurable effect.

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