Real experience: my wife works in a software company in R&D. The company, which had already gone through two transfers from investment funds without affecting the staff, was sold again to another fund in 2021. An investment that I think was around 100 million dollars. 2 years later, in 2023, radical cuts were decided for R&D, with the prospect of investing again if the product were to produce acceptable cash flows. My wife was not fired but decided to resign knowing that the goals are impossible. And in fact, in a month she will start working in the R&D of a strategically autonomous company, albeit participated by funds.
"The best policy is to support R&D efforts through fiscal policy measures."
But to do that, you need to keep the debt/GDP ratio under control. And to keep the debt-GDP ratio under control, you need to keep inflation under control. And to keep inflation under control, you need to maintain efficient free trade. And to maintain efficient free trade, you need to ease international tensions. And since debt is useful for everyone, the conclusion is that either the large economies cooperate, or whoever is in charge ends up losing power in a bad way. And since no one likes to lose power, I think they will come to terms. An example for me is Saudi Arabia, which with the prospect of losing importance of oil is getting closer to Israel to strengthen its position.
1. The relationships found seem unsupported. That chart shown is misleading; too short a period to build a relationship (correlation, especially short-term, is not causation) and seems a bit too good. The paper breaks the effects down in more detail and where subset of VC sensitivity is “as much as 25%” change. This raises a flag in my mind as that degree of responsiveness to interest rate changes for businesses that generally have no debt and have cost of capital hurdle rates of 25-50% all equity seems off given that a few percentage change would impact them so much as the funds are locked up for years.
2. Taking the paper’s findings still is equating changes in short-term rates with a long-term investment. How is this logically make sense? If I as a business have a R&D program that is geared toward new products that will be sold for years forward (as opposed to near term S&M, the sales and marketing type and not the other that may have horizons of maybe months), my decision on investing is also if similar tenor, hence it is the move in long-term rates that matter. The paper does not address this. The paper also assumes that residual statistical effects, note symmetrical in effect, that are up to 5 years constitute the long-term (maybe news to many who run businesses). That said, I am sympathetic, is difficult to get executives to think past the next flash monthly earnings release, sigh.
3. The fed funds rate is not a business rate benchmark (banks set their rates as a spread to their wholesale costs of deposits and market issued), nor really is a treasury bill, and even a floating rate instrument, say bank revolver, has a large and variable credit spread component to address. Assuming a short-term rate mattered, this is one is too ‘distant’ from the user in question; non-financial businesses. Changes in credit spreads and effective, not theoretical, equity risk premiums may be much more important to look at.
4. Even in a world where people actually believe a central bank can move short term rates where they want, the belief that long-term rates are ‘controlled’ as well is not a conclusion many would support. As such, the market-determined long-term rate should be guiding R&D relatively efficiently by signaling when the ROI on R&D is sufficient for the cost of capital (yes, as imperfectly measured as all things are). Government intervention (in most cases) would distort and waste funds. The paper finds the results are symmetric so to avoid over-investment would the government then be capable of dialing back fiscal support as rates fluctuate?
5. A 1% sustained change in rates (real or nominal) is fairly large for interest rates but for discretionary spending by a company is a fairly small variation and taken to an extreme, say 5% move leading to a 5% reduction in R&D is hardly comparable (if costs of capital rise 5% and investment ‘only’ drop by 5% seems that executives are not doing their jobs in cutting unprofitable outlays in a world where there may be high inflation). I leave it also for analysis of real vs nominal rate change effects that have different implications to pass-through returns. Even if some ‘short-sighted’ managers shave funds as rate rise, whether to use as a cash cushion for liquidity or in juicing profits, this behavior will be hard to discern from ‘far-sighted’ managers cutting programs that are no longer marginally worthwhile. The paper notes that larger companies reduced R&D is “likely driven by reduced demand” anyway, and while not elaborated on would imply they are viewing conditions in an ‘appropriate’ economic framework.
The paper has manufactured a problem for monetary policy and concludes, without any support, that in ‘economic downturns’ one should apply other policies (fiscal, tax, regulatory… alas, too much for them to commit, just toss into somebody else’s policy yard to handle) to ‘support’ innovation. Why is this an imperative? Why not employment rate? Why not subsidize CEO private jet refits (I hear shag rugs are back)?
Real experience: my wife works in a software company in R&D. The company, which had already gone through two transfers from investment funds without affecting the staff, was sold again to another fund in 2021. An investment that I think was around 100 million dollars. 2 years later, in 2023, radical cuts were decided for R&D, with the prospect of investing again if the product were to produce acceptable cash flows. My wife was not fired but decided to resign knowing that the goals are impossible. And in fact, in a month she will start working in the R&D of a strategically autonomous company, albeit participated by funds.
"The best policy is to support R&D efforts through fiscal policy measures."
But to do that, you need to keep the debt/GDP ratio under control. And to keep the debt-GDP ratio under control, you need to keep inflation under control. And to keep inflation under control, you need to maintain efficient free trade. And to maintain efficient free trade, you need to ease international tensions. And since debt is useful for everyone, the conclusion is that either the large economies cooperate, or whoever is in charge ends up losing power in a bad way. And since no one likes to lose power, I think they will come to terms. An example for me is Saudi Arabia, which with the prospect of losing importance of oil is getting closer to Israel to strengthen its position.
Issues with the argument made:
1. The relationships found seem unsupported. That chart shown is misleading; too short a period to build a relationship (correlation, especially short-term, is not causation) and seems a bit too good. The paper breaks the effects down in more detail and where subset of VC sensitivity is “as much as 25%” change. This raises a flag in my mind as that degree of responsiveness to interest rate changes for businesses that generally have no debt and have cost of capital hurdle rates of 25-50% all equity seems off given that a few percentage change would impact them so much as the funds are locked up for years.
2. Taking the paper’s findings still is equating changes in short-term rates with a long-term investment. How is this logically make sense? If I as a business have a R&D program that is geared toward new products that will be sold for years forward (as opposed to near term S&M, the sales and marketing type and not the other that may have horizons of maybe months), my decision on investing is also if similar tenor, hence it is the move in long-term rates that matter. The paper does not address this. The paper also assumes that residual statistical effects, note symmetrical in effect, that are up to 5 years constitute the long-term (maybe news to many who run businesses). That said, I am sympathetic, is difficult to get executives to think past the next flash monthly earnings release, sigh.
3. The fed funds rate is not a business rate benchmark (banks set their rates as a spread to their wholesale costs of deposits and market issued), nor really is a treasury bill, and even a floating rate instrument, say bank revolver, has a large and variable credit spread component to address. Assuming a short-term rate mattered, this is one is too ‘distant’ from the user in question; non-financial businesses. Changes in credit spreads and effective, not theoretical, equity risk premiums may be much more important to look at.
4. Even in a world where people actually believe a central bank can move short term rates where they want, the belief that long-term rates are ‘controlled’ as well is not a conclusion many would support. As such, the market-determined long-term rate should be guiding R&D relatively efficiently by signaling when the ROI on R&D is sufficient for the cost of capital (yes, as imperfectly measured as all things are). Government intervention (in most cases) would distort and waste funds. The paper finds the results are symmetric so to avoid over-investment would the government then be capable of dialing back fiscal support as rates fluctuate?
5. A 1% sustained change in rates (real or nominal) is fairly large for interest rates but for discretionary spending by a company is a fairly small variation and taken to an extreme, say 5% move leading to a 5% reduction in R&D is hardly comparable (if costs of capital rise 5% and investment ‘only’ drop by 5% seems that executives are not doing their jobs in cutting unprofitable outlays in a world where there may be high inflation). I leave it also for analysis of real vs nominal rate change effects that have different implications to pass-through returns. Even if some ‘short-sighted’ managers shave funds as rate rise, whether to use as a cash cushion for liquidity or in juicing profits, this behavior will be hard to discern from ‘far-sighted’ managers cutting programs that are no longer marginally worthwhile. The paper notes that larger companies reduced R&D is “likely driven by reduced demand” anyway, and while not elaborated on would imply they are viewing conditions in an ‘appropriate’ economic framework.
The paper has manufactured a problem for monetary policy and concludes, without any support, that in ‘economic downturns’ one should apply other policies (fiscal, tax, regulatory… alas, too much for them to commit, just toss into somebody else’s policy yard to handle) to ‘support’ innovation. Why is this an imperative? Why not employment rate? Why not subsidize CEO private jet refits (I hear shag rugs are back)?