For release: Feb. 28, 2003

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Businesses’ Concerns About “Geopolitical Risk” Seen Delaying Business Fixed Investment, Says St. Louis Fed’s Poole

ST. LOUIS, Mo.— Current concerns about “geopolitical risk” appear to be contributing to an incentive for businesses to delay fixed investment, according to William Poole, president of the Federal Reserve Bank of St. Louis.

Speaking to the Missouri Valley Economics Association, Poole said, “On the positive side, business investment spending is receiving a boost from accelerated first-year depreciation allowances for new plant and equipment. The Job Creation and Worker Assistance Act of 2002 allows firms to claim a first-year depreciation allowance of 44 percent instead of the usual 20 percent.”

Poole said he believes that in coming quarters businesses will begin to act on declines in the cost of capital. “Combining the risk-free rate, a risk premium and the
incentive to wait to invest, the cost of capital is now back down to levels last seen in early 1998 and early 1999—at least when using an investment grade corporate bond yield to measure the benchmark return,” Poole said. “If instead we use the expected return on equities as a benchmark return, the cost of capital today is considerably lower today than in the late 1990s.”

Poole said a natural question is whether monetary policy can encourage investment spending in the current environment. The answer is yes, he said, by avoiding any inflation surprises, both inflationary and deflationary, which will help insure that market risk premiums are not elevated by an unnecessary inflation risk premium. “If we at the Fed do our part,” he said, “firms and individuals will receive clearer signals of the expected rate of return required of each type of prospective investment project, which will help the market weed out the bad from the good. The Fed, obviously, has no direct role in resolving the geopolitical uncertainties but does have a role, which I think it is fulfilling, in maintaining a sound long-run financial environment.”

Poole said “If you know me, you know that I am very bullish on the long-term capacity of the American economy to generate plenty of good investment opportunities through innovation and productivity growth.”

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