How High Interest Rates Harm Innovation

For more than 50 years, most economists have agreed that actions taken by central banks to stabilize prices and output can have short-term—but not long-term—effects. The late Milton Friedman, a Nobel laureate who studied and worked at the University of Chicago, argued as much during a 1968 presidential address to the American Economic Association.

But monetary policy in the United States might not be so neutral in the longer term, especially related to its impact on innovation, according to research from Chicago Booth’s Yueran Ma and Frankfurt School of Finance and Management’s Kaspar Zimmermann. Their analysis suggests that high interest rates can discourage companies and industries from investing in technology, leading to a slower pace of innovation that can limit economic growth.

To understand the link between innovation funding and monetary-policy shocks, Ma and Zimmermann studied widely used innovation indicators, including aggregate US investment in intellectual property as well as venture-capital investment, public companies’ research and development spending, and patent filings. Their analysis covers monetary-policy shocks between 1969 and 2007 and focuses on the effects of conventional policy—namely adjusting interest rates—rather than unconventional moves such as quantitative easing.

For every 1 percentage point rise in interest rates, Ma and Zimmermann calculate, R&D spending fell by between 1 and 3 percent and VC investment fell by about 25 percent one to three years after the hike. Similarly, within four years of an interest-rate increase, patent filings and innovation each declined by 9 percent.

After five years, the researchers infer, these shifts can lower overall economic output by 1 percent and decrease total factor productivity, a measure of how many more goods and services are produced with the same resources, by 0.5 percent.