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Public Interest Representation on Federal Reserve Bank Directorates

Ervin Miller

increase in the scarcity of funds. If, instead, the short run refers to a definite time period, such as one year, then in one of our examples the short-run decline in investment would come to I.28 percent,5 and in the others it would be 20 percent. Or, to put this differently, how should we interpret the elasticity in the following example? T = $I5,000, D = $500, and P is initially 6 years. Then the age at replacement is 5 years. If there should be increase of ioo percent in the required rate of return -to use Duesenberry's phrase -with the payoff period being cut to 3 years, the age at which replacements are made would be io years. But this would imply a 20 percent reduction in investment lasting for 5 years. Query: is the investment function elastic? Now, let us consider the denominator in the measure of elasticity. It should, of course, refer to the relative change in interest rates, or if desired, in the required rate of return. If the item has a long life it is nearly correct to identify the percentage fall in the payoff period with the percentage increase in the required rate of return. But if the item is expected to have a short life, there would be a very considerable difference. To illustrate: a project which has a 3-year payoff period and an expected life of 4 years would yield about 23 percent. If the payoff period of this item were reduced to 2 years, its yield would come to 47 percent.6 In short, it is dangerous to identify the percent change in the payoff with the percent change in yields except when the item is expected to have an operating life of, say, ten or fifteen years, or longer.7 To summarize: the investment response that Duesenberry finds is misleading, the change in interest rates as he calculates it could be wrong, and the assumptions upon which he bases his illustration are arbitrary. It is hard to take this seriously as evidence for or even suggestive of a very elastic investment function. What makes the whole matter most surprising is that just before setting out his example he identified the elements upon which the elasticity really does depend the pattern of yields expected on all the various projects. But he has not used them.

DOI

10.2307/1927479

Volume

43 (4)

Pages

380

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