The impact of financial variables and capacity utilization on driving aggregate investment in emerging economies

Abstract

This paper investigates the impact of financial variables and capacity utilization on driving aggregate investment in emerging economies. This investigation is vital because it allows an empirical understanding of investment drivers, thus allowing policymakers to form fiscal and monetary policy that supports investment growth. Using quarterly data from public economic databases, we model a Keynesian investment function based on the existing theory, using OLS as an analysis method. We find that the profit rate is a statistically significant and strong explanator of investment in most of the countries we investigate. We also find that capacity utilization is statistically significant with a varying degree of explanatory strength in the countries we investigate. Additionally, we exhibit mixed results for financial stress and Tobin’s Q across the different countries, where we find varying signs and levels of significance. Our results expose a flaw in the manner which central banks implement monetary policy as they do not consider the rate of profit when setting interest rates. Based on our findings, we recommend that it is essential for policymakers in emerging economies to form a policy framework that maximizes aggregate demand to ensure full capacity utilization and profits. This should be done by including the spread between the rate of profit and interest rates as a key variable in making policy decisions. While the results are conclusive and allow us to make recommendations, the dynamics between financial stress and investment still require further investigation. Our econometric model still leaves a significant portion of investment unexplained. Our interpretation of this result is that the “Animal Spirits” hypothesis may cause this; however, this can be expanded on in other research (Keynes, John, 1936).