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1 1 (March 16, 2021)

handle is hein.crs/govecrc0001 and id is 1 raw text is: I rn~ g th k~4. Iatvii ~t en W~ 4 9 Updated March 16, 2021 Introduction to U.S. Economy: Business Investment What Is Business Investment? Business investment is spending by private businesses and nonprofits on physical capital-long-lasting assets used to produce goods and services. Physical capitalis generally groupedinto three categories: equipment (e.g., machinery or computers), structures (e.g., offices or warehouses), and intellectual property (e.g., software developmentor research and development). Through investment, businesses can build up their stockof physicalcapital, which increases theircapacity to produce goods and services. For example, when a restaurant purchases an additional grill, it increases its capacity to prepare food over any giventime period. However, physical capitaltends to become less productive over time due to wear and tear and must eventually be replaced as it breaks down, a process known as depreciation. For a firm to continually increaseits stock of physical capital, and therefore its productive capacity, it must investin new physicalcapital faster than its current physicalcapitalis depreciating. The same is true for the economy as a whole: Forthe economy's stock ofphy sical capitalto increase, the investment rate mustexceed the rate at which physical capitaldepreciates. Economic Considerations Business investment can affect the economy's short-term and long-termgrowth. In the shortterm, an increasein businessinvestment directly increases the current levelof gross domestic product (GDP), because physical capital is itself produced and sold. Business investment is one of the more volatile components of GDP and tends to fluctuate significantly fromquarterto quarter. In the long term, a largerphysical capital stockincreases the economy's overallproductive capacity, allowing more goods and services tobe produced with the s ame levelof labor and otherresources. Long-termeconomic growth generally depends on growth in the economy's productive capacity rather than swings in supply and demand. In turn, faster economic growth generally translates into faster income growth and improved living standards. For additionaldiscussion of the long-termdrivers of economic growth, see CRS In Focus IF10557, Introduction to U.S. Economy: Productivity,by Marc Labonte. Drivers of Business Investment The main determinants of business investment are broader economic conditions, business confidence and expectations, and long -terminterest rates. The business cycle is one of the largest drivers of business investment. As a recession occurs, businesses tend to see a decline in demand for their products, which leads themto reduce investment spending. Alternatively, during ahealthy economic expansion, businesses tend to see rising demand for their products, which leads themto increase investment in order to increas e production to accommodate the increased demand. Figure 1 illustrates this phenomenon- both business investment andtheinvestmentrate fellin the beginning ofthe 2007-2009 recession and the recession causedby COVID-19. For more information regarding the businesscycle, seeCRS In Focus IF10411, Introduction to U.S. Economy: The Business Cycle and Growth, by Lida R. Weinstock. Figure 1. Recent Business Investment Trends 2005-2020 00 - Source: Bureau of Economic Analysis. Notes: The investment rate is measured as theyear-over-year change in real business investment. Gray bar indicates recession. Business confidence and future expectations for the economy are also expected to influence business investment. If business owners expect rising sales and improving economic conditions, they are more likely to invest in their businesses, because they anticipate increased demand for their goo ds and services. Bus iness confidence and future expectations can be unpredictable and difficult to influence through public policy. Business investment is typically financed through loans and other debt. As such, interest rates influence business investment decisions by either increasing or decreasing the co st for a bus iness to borrow funds, thus affecting the profitability of making additional investments. All else equal, when the interest rate rises, the co st of investing- the interest the business will pay-rises, resulting in les s investment overall. This type of interest-sensitive behavior is what allows monetary policy to function. The Federal Reserve changes the short-termfederal funds rate, which in turn affects other interestrates, in an effort to affect business investment (and interest-sensitive consumer spending). For additional discussionof monetary policy and the Federal Reserve, see CRS Report RL30354, Monetary https://crsrept

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