Investment is the amount of money spent on capital goods. Capital goods are basically fixed assets or fixed factors of production in the economy. They may include machinery, technology, factory buildings and office premises. Investment is an important factor in an economy since it is a major contributor to the Gross Domestic Product of the economy by influencing the economy’s production capacity. Since investment is financed by either savings or borrowed funds, the level of investment available for any economy will be influenced by factors including interest rates, economic growth and investor confidence.
Higher interest rates lead to lower investment in an economy. This is because when interest rates are higher, it is more expensive to borrow, thus making borrowed funds less available. Additionally, when interests are higher savings attract better returns in banks thereby leading to unavailability of money for investment. However, in cases where the rate of return on an investment is higher than the interest rate, the prevailing high interest rate will not deter investment into the economy.
The economic growth rate of the economy also affects the level of investment in an economy. In a negative economic growth rate era, otherwise known as recession, investment is unattractive because the demand for products falls. In the era of economic recovery, firms and investors will invest more to meet future demands. Additionally, economic growth rate also drives investor confidence. Investor confidence in the future of the economy is also a major factor determining the amount of investment. Generally, investor confidence is based on hope and not much hardcore facts. It is mostly based on the prevailing political and economic climate in the economy. When faced with political uncertainty, investor confidence is lowered, and therefore, less investment is realized in the period, and vice versa.
In conclusion, there are several other factors that influence the increase and decrease of investment into a modern economy, but the bottom line principle is the efficiency of these factors. That is, the rate of return on the investment needs to be higher than the cost of capital.