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Interest Rates, Irreversibility, and Backward-Bending Investment

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  • Raj Chetty

Abstract

This paper studies the effect of interest rates on investment in an environment where firms make irreversible investments with uncertain pay-offs. In this setting, changes in the interest rate affect both the cost of capital and the cost of delaying investment to acquire information. These two forces combine to generate an aggregate investment demand curve that is a backward-bending function of the interest rate. At low rates, increasing the interest rate raises investment by increasing the cost of delay. Copyright 2007, Wiley-Blackwell.

Suggested Citation

  • Raj Chetty, 2007. "Interest Rates, Irreversibility, and Backward-Bending Investment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(1), pages 67-91.
    • Handle: RePEc:oup:restud:v:74:y:2007:i:1:p:67-91
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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2007.00414.x
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    Cited by:

    1. Anastasios, Dosis, 2019. "Interest Rates and Investment Under Competitive Screening and Moral Hazard," ESSEC Working Papers WP1902, ESSEC Research Center, ESSEC Business School.
    2. Gutiérrez, Óscar, 2020. "On the definition of the investment-uncertainty relationship," Journal of Economics and Business, Elsevier, vol. 112(C).
    3. Kropp, Jaclyn D. & Power, Gabriel J., 2016. "Asset fixity and backward-bending investment demand functions," Research in International Business and Finance, Elsevier, vol. 38(C), pages 151-160.
    4. Ehud Lehrer & Tao Wang, 2022. "The Value of Information in Stopping Problems," Papers 2205.06583, arXiv.org.
    5. Óscar Gutiérrez, 2021. "Real options and the perverse effect of interest rates on investment timing," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(3), pages 3984-3996, July.
    6. Guceri, Irem & Albinowski, Maciej, 2021. "Investment responses to tax policy under uncertainty," Journal of Financial Economics, Elsevier, vol. 141(3), pages 1147-1170.
    7. Arestis, Philip & Gonzalez-Martinez, Ana Rosa, 2016. "Revisiting the accelerator principle in a world of uncertainty: Some empirical evidence," Economic Modelling, Elsevier, vol. 56(C), pages 35-42.
    8. Liang Peng & Thomas G. Thibodeau, 2020. "Interest Rates and Investment: Evidence from Commercial Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 60(4), pages 554-586, May.
    9. Bozhechkova, A.V. (Божечкова, А.В.) & Sinelnikova-Muryleva, Elena Vladimirovna (Синельникова-Мурылева, Елена Владимировна), 2016. "The Impact of Higher Interest Rates on Loans to the Economic Growth of the Russian Federation in the Current Environment [Влияние Высоких Процентных Ставок По Заимствованиям На Экономический Рост Р," Working Papers 21310, Russian Presidential Academy of National Economy and Public Administration.

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