Maintstream research seems to agree with Austrian theory on the distortions caused by low interest rates

See The Slow Vindication of the Austrians by Benjamin J. Thompson at FEE. Excerpt:

"Earlier this month in The New York Times, Neil Irwin noticed with some consternation that low interest rates have a strange way of favoring the biggest players in a market. The revelation came from a chance encounter with on-the-ground experiences of actual entrepreneurs:

Atif Mian, an economist at Princeton, was recently having dinner with a colleague whose parents owned a small hotel in Spain. The parents had complained vociferously, Mr. Mian recalled the friend saying, about the European Central Bank’s[ECB] low interest rate policies.

That didn’t make sense, Mr. Mian thought. After all, low interest rates should make it easier for small business owners to invest and expand; that’s one of the reasons central banks use them to combat economic weakness.

The owners of the small hotel didn’t see it that way. They thought that big hotel chains were the real beneficiaries of low interest rate policies, not a mom-and-pop operation.

Empirical Validation

The gee-golly head-scratching about this one strikes me as pretty funny since the Austrians have argued for the last half-century or more that artificially low interest rates bias the market in favor of the Large. Interest rates are the price of access to future money today subject to the same supply-and-demand pressures as anything else that has a price. Depending on how much stored capital is sitting in the banks to lend and how many demands there are to borrow, a natural market interest rate would emerge. The ECB, just like the Federal Reserve, takes it upon itself to press a finger on the scale and push that price down.

Since prices carry information, wrong prices carry wrong information. In the case of interest rates fixed to be too low, it sends the message that the economy is ready and waiting for very large capital projects. Production shifts to larger, more time-intensive projects at the cost of smaller ones. If this goes on long enough, it becomes the poison boom that creates a bust later, as it turns out consumers weren’t actually waiting to buy the ambitious finished product. The top-heavy house of cards, built on an illusion of rich-and-waiting customers, topples over.

So as Atif Mian and his colleague Ernest Liu started thinking this through, what did they find?

Imagine a town in which two hotels are competing for business, one part of a giant chain and one that is independent… When interest rates fall to very low levels, though, the payoff for being the industry leader rises, under the logic that a business generating a given flow of cash is more valuable when rates are low than when they are high. (This is why low interest rates typically cause the stock market to rise.)

A market leader has more to gain from investing and becoming bigger, and it becomes less likely that the laggards will ever catch up.

“At low interest rates, the valuation of market leaders rises relative to the rest,” Mr. Mian said. “Amazon becomes a lot more valuable as interest rates fall relative to a smaller player in the same industry, and that gives a huge advantage to Amazon.”

Got there by a slightly different route, but you still got there.

The best part comes next:

The researchers tested the theory against historical stock market data since 1962, and found that falling interest rates indeed correlated with market leaders that outperformed the laggards.

That’s right. This empirical validation of the Austrian view had been sitting there waiting to be acknowledged for decades:

“There’s a view that we can solve all of our problems by just making interest rates low enough,” Mr. Mian said. “We’re questioning that notion and believe there is something else going on.”

Indeed."

See Low Interest Rates, Market Power, and Productivity Growth by Ernest Liu, Atif Mian & Amir Sufi. Here is the abstract:

"How does the production side of the economy respond to a low interest rate environment? This study provides a new theoretical result that low interest rates encourage market concentration by giving industry leaders a strategic advantage over followers, and this effect strengthens as the interest rate approaches zero. The model provides a unified explanation for why the fall in long-term interest rates has been associated with rising market concentration, reduced business dynamism, a widening productivity-gap between industry leaders and followers, and slower productivity growth. Support for the model’s key mechanism is established by showing that a decline in the ten year Treasury yield generates positive excess returns for industry leaders, and the magnitude of the excess returns rises as the Treasury yield approaches zero."

See How Low Interest Rates Can Freeze the Economy by David Harrison of The WSJ. Excerpt:

"Imagine you’re the owner of a small restaurant and you’re thinking of expanding. If interest rates are high, you might think twice. When rates fall, you might be more willing to borrow to grow your business.

But the big chain restaurant down the street also borrows at similarly low rates to fund a much larger expansion that could steal your customers and perhaps put you out of business.

Over the past two decades or so that phenomenon has been playing out across industries, making the overall economy less dynamic, according to new research by economists Ernest Liu and Atif Mian of Princeton University, and Amir Sufi of the University of Chicago’s Booth School of Business.

When interest rates fall, they find, the big players in an industry can take advantage to a far greater extent than their smaller counterparts. That allows them to grow faster and become more productive, but it also makes it harder for everybody else to keep up.

Over time, the smaller players get discouraged and stop investing in new products or technologies. And the leaders become so big that they’re no longer vulnerable to competition. They also pull back from investing. With market power increasingly concentrated in a few big firms, fewer entrepreneurs will decide to open new businesses."

"Under the framework outlined by the researchers, it can take decades for lower rates to make an economy less dynamic. In fact, they find that growth quickens in the early years before slowing down.

That’s because when interest rates first start falling, smaller firms will borrow aggressively and invest to try to catch up to their bigger rivals, speeding up productivity growth.

That’s what happened in the 1990’s. A decline in interest rates, as measured by the 10-year Treasury yield, led big and small firms to invest. Productivity growth averaged 2.2% a year in the 1990’s and 2.8% in the 2000’s.

But around 2003, productivity growth started to slow even though interest rates kept falling. That’s roughly when the smaller players gave up catching up with the leaders, Mr. Sufi said."