+1 vote
asked ago in General Economics Questions by (240 points)
I recently followed MIT online lectures for economy and come across this sentence -

one of the reason for investments decline in recession is bad expectations about economy -----> leading to Higher capital output ratio -------> lower Investments

How does bad expectations leads to higher capital output ratio and then why does that translates into low investments?

My thoughts - Bad expectations about economy might cause firms to severely cut their production. Since, output gets lower and output being in the denominator makes the whole fraction to be bigger so we get higher capital output ratio and that discourages investments because cost of capital is high so with the lower output it would be hard to pay off the loans. Is my reasoning correct? Is it conceptually sound? Am I thinking clearly, simple & effectively? I am not sure about the answer neither with my line of reasoning.

Kindly guide me to correct approach or rationale.

Thank you so much

1 Answer

0 votes
answered ago by (330 points)
In my view, your reasoning is correct.
commented ago by (2.7k points)
I agree. Bad expectations and higher capital cost related to output can decrease investment.
commented ago by (240 points)
Thank you for the affirmation! I was perplexed after thinking about this over and over.