A Warsh-Spence Smackdown from 78 Years Ago...
The effects of either a rise of liquidity preference or (with a minus sign) of expansionary open-market operations like quantitative easing:
(1937): The General Theory of Employment: "The quantity of money and the amount of it required in the active circulation for the transaction of current business...
...(mainly depending on the level of money-income) determine how much is available for inactive balances, i.e. for hoards. The rate of interest is the factor which adjusts at the margin the demand for hoards to the supply of hoards.... The owner of wealth, who has been induced not to hold his wealth in the shape of hoarded money, still... can lend his money at the current rate of money-interest, or... purchase some kind of capital-asset.... In equilibrium these two alternatives must offer an equal advantage.... The prices of capital-assets move until, having regard to their prospective yields and account being taken of all those elements of doubt and uncertainty, interested and disinterested advice, fashion, convention and what else you will which affect the mind of the investor, they offer an equal apparent advantage to the marginal investor who is wavering between one kind of investment and another.
This, then, is the first repercussion of the rate of interest... on the prices of capital-assets.... Capital-assets are capable, in general, of being newly produced.... Thus if the level of the rate of interest taken in conjunction with opinions about their prospective yield raise the prices of capital-assets, the volume of current investment (meaning by this the value of the output of newly produced capital-assets) will be increased; while if, on the other hand, these influences reduce the prices of capital-assets, the volume of current investment will be diminished.
It is not surprising that the volume of investment, thus determined, should fluctuate widely from time to time. For it depends on two sets of judgments about the future, neither of which rests on an adequate or secure foundation--on the propensity to hoard, and on opinions of the future yield of capital-assets. Nor is there any reason to suppose that the fluctuations in one of these factors will tend to offset the fluctuations in the other...
Now you could argue that this model is too simple--that in fact there are other more complicated things going on that reverse the logic Keynes set out back in 1937. But if you are going to assert that, you have to say what those more complicated things going on are. And Warsh and Spence do not.
As Charles Steindel commented:
: "Indeed, acknowledging that the models don't fit very well, it is rather flabbergasting to assert that elevated values of Tobin's Q are bad for capital spending..."
I think that says it all...
