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Why Is Investment So Soft?

Three and a half years after the beginning of the recession, real GDP is still below its pre-recession peak. One reason is that firms’ investment (private nonresidential fixed investment) has not recovered. Currently, it is down 12 percent relative to its level at the start of the recession. While investment in equipment and software has bounced back and is now at pre-crisis levels, investment in nonresidential structures remains depressed. (Click here for more about investment in structures.) This behavior is unusual compared to past business cycles, when investment returned to its pre-recession peak level much more rapidly. Even during the 1973-1975 and 2001 cycles, in which investment remained depressed for years, it was much closer to its pre-recession peak by this point in the recovery.

Figure 1. Nonresidential Fixed Investment

Whatever is hindering the capital spending of firms, it is not likely to be the financial conditions in which they are operating. After weakening during the financial crisis, corporate balance sheets have since strengthened. Firms are holding relatively high levels of liquid assets. Profits and cash flows have been growing rapidly, driven by high productivity and low labor costs, and are now at record-high levels. External finance conditions continue to be favorable: Firms have been able to issue bonds and raise external funds at attractive, low bond yields.

Why then are firms still reluctant to invest? And why are they shying away from long-lived assets in particular? The most important factor is the large overhang of unused and underutilized structures and the excess capacity present in the economy. During the years before the crisis, high real estate prices encouraged households and firms to overinvest in structures. This generated an overhang of structures, which is now weighing on current real estate prices and investment. Also, with so much capital installed, capacity utilization rates are relatively low, below 80 percent, and there is little incentive to add to capacity. (Click here for more about structural overhang and capacity utilization.)

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