Investment and US Fiscal Policy in the 1990s

In this working paper, Steven Fazzari presents new empirical research that attempts to measure the relative strength of fiscal policy on investment through the cost of capital, firms’ financial circumstances, and sales growth. Fazzari argues against the crowding-out effect and claims that even if the connection between the national budget deficit and interest rates is valid, the linkage between interest rates and private sector investment is at best, misguided. While neoclassical empirical studies have found a statistically significant relationship between investment and the cost of capital, Fazzari contends that high degree of explanatory power yielded by many of these investigations is due to the fact that they fail to separate the effects of sales or output growth from the cost of capital in determining investment, which renders the source of their significance unclear. The focus of fiscal policy is therefore difficult to determine./p>