Anaemic Recovery: The Vicious Circle of Consumption and Investment

Abstract

Investment is the most volatile component of aggregate demand. In the US economy the standard deviation of investment is five times bigger than that of GDP; for example, since the Second World War the standard deviation of investment has been 14 per cent, while that of GDP is only 2.8 per cent. The downswing of investment invariably precedes a recession, but investment, and in particular investment in inventories, also leads the recovery. Investment is properly defined as real (that is, inflation-adjusted) gross private domestic investment in fixed capital. It is expenditure incurred by companies and households that enhances the net capital stock of the economy, namely the productive capital and housing of labour, or replaces obsolete capital stock. Investment is subdivided into residential and non-residential and investment in inventories. Residential investment is expenditure on building new houses, whereas expenditure on house maintenance is classified as a part of consumption. Non-residential investment includes expenditure on factory buildings (structures) and equipment (such as machinery, hardware and software). The latter has become one of the biggest components of non-residential investment.