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1 1 (December 29, 2022)

handle is hein.crs/govejzg0001 and id is 1 raw text is: Congressional Research Service informing the legislative debate since 1914 0 Updated December 29, 2022 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 capital is generally grouped into three categories: equipment (e.g., machinery or computers), structures (e.g., offices or warehouses), and intellectual property (e.g., software development or research and development). Through investment, businesses can build up their stock of physical capital, which increases their capacity to produce goods and services. For example, when a restaurant purchases an additional grill, it increases its capacity to prepare food over any given time period. However, physical capital tends 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 increase its stock of physical capital, and therefore its productive capacity, it must invest in new physical capital faster than its current physical capital is depreciating. The same is true for the economy as a whole: For the economy's stock of physical capital to increase, the investment rate must exceed the rate at which physical capital depreciates. Economic Considerations Business investment can affect the economy's short-term and long-term growth. In the short term, an increase in business investment directly increases the current level of 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 from quarter to quarter. In the long term, a larger physical capital stock increases the economy's overall productive capacity, allowing more goods and services to be produced with the same level of labor and other resources. Long-term economic 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 additional discussion of the long-term drivers of economic growth, see CRS In Focus IF10557, Introduction to U.S. Economy: Productivity, by Lida R. Weinstock. Drivers of Business Investment The main determinants of business investment are broader economic conditions, business confidence and expectations, and long-term interest 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 them to reduce investment spending. Alternatively, during a healthy economic expansion, businesses tend to see rising demand for their products, which leads them to increase investment in order to increase production to accommodate the increased demand. Figure 1 illustrates this phenomenon- both business investment and the investment rate fell in the beginning of the 2007-2009 recession and the recession caused by COVID-19. For more information regarding the business cycle, see CRS In Focus IF10411, Introduction to U.S. Economy: The Business Cycle and Growth, by Lida R. Weinstock. Figure I. Recent Business Investment Trends QI 2005-Q3 2022 3,000 _snne~e~ 2,500 1u 0 V 2,000 a o Source: Bureau of Economic Analysis. Notes: The investment rate is measured as the year-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 goods and services. Business 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 cost for a business to borrow funds, thus affecting the profitability of making additional investments. All else equal, when the interest rate rises, the cost of investing- the interest the business will pay-rises, resulting in less investment overall. This type of interest-sensitive behavior is what allows monetary policy to function. The Federal Reserve changes the short-term federal funds rate, which in turn affects other interest rates, in an effort to affect business investment (and interest-sensitive consumer spending). For additional discussion of monetary policy and

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