Chart of the Week: Slaying the zombies

Previous Fathom research has identified a link between persistently low interest rates and weak productivity outturns, a phenomenon known in the academic literature as zombification. The premise for this theory is that holding borrowing costs at abnormally low levels for a prolonged period allows unprofitable firms to stay in business. Not only are these firms unproductive, but their survival blocks the emergence of younger, more innovative competitors. Expressed another way, Fathom thinks that low interest rates have stifled the forces of creative destruction. This is reflected by a fall in the rates of corporate failures and corporate births, and is one explanation for the so-called ‘productivity puzzle’. But could we now be at a turning point? Corporate failures have been rising since 2015 when the Federal Reserve began its previous tightening cycle, and they shot up during the pandemic. Faced with higher inflation, the central bank is now raising rates again. The key questions for the medium-term outlook are whether this leads to an increase in corporates failures, and the extent to which that passes through to higher productivity growth. In Fathom’s view, US rates are likely to peak at a little under 3% and that this probably won’t be sufficient to slay the zombies or to deliver a material pickup in productivity growth.

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