How Zero Interest Rates Encourage Zombie Companies

At the balance-sheet meeting, the company still looks alive. Its machines are running, wages are being paid, and the bank has extended its credit line. Only the real question remains unanswered: would this business survive if capital had a price again?

That is where the potential problem of zero interest begins. A company can continue not because it is especially productive, its products urgently needed, or its use of capital better than its competitors’. It also survives because refinancing remains cheap. Old debts are rolled over, new loans plug old gaps, and investors accept valuations plausible only at extremely low capital costs. Zero interest thus changes more than borrowing costs. It changes selection within capitalism.

In a market economy, interest is more than a number in a loan agreement. From the Austrian school’s perspective, it coordinates present and future. It indicates how scarce capital is, how strongly people prefer the present to the future, and which projects pay under real conditions of scarcity. Savers forgo consumption today. Investors claim real resources: labour, machinery, energy, intermediate goods and management time. Interest relates these two sides.

When interest rises, the market is not simply saying that loans are becoming more expensive. It is saying that capital is scarce and future projects must clear a higher hurdle. If interest falls because of voluntary saving, that may signal more real resources available for longer production processes. But if it falls because monetary policy artificially pushes it down, a different signal emerges: businesses, investors and banks perceive conditions of scarcity that do not actually exist. Economic calculation becomes less precise.

That calculation begins with an apparently technical quantity: the discount rate. Companies and investors assess projects not only by their cost today but also by the cash flows expected tomorrow, the day after and many years from now. Those future payments are discounted to the present. The higher the discount rate, the less a distant cash flow is worth today. The lower the rate, the more valuable the same future appears in today’s price.

This sounds abstract, but its consequences are concrete. When the discount rate falls, long-term projects look more attractive. Profits far in the future move closer to the present within the model. Property with expected rental income, shares with future earnings, companies whose earnings story is more promised than delivered: all receive a higher calculated present value at lower interest rates. A bet on later more readily becomes an acceptable price today.

This creates the first part of the zombie effect. Projects that would be rejected at normal capital costs clear the hurdle. Companies whose operating earnings barely cover debt, investment and running costs appear financeable. The difference between a sustainable business model and one prolonged by cheap money narrows. Not because the companies have become more productive, but because the yardstick has softened.

The second part works through asset prices. When safe investments yield little, investors seek returns elsewhere. Bonds become more expensive, share valuations rise, property prices climb and company valuations expand. Again, no single number is decisive; it is the direction of the incentive: low interest rates increase willingness to pay more for future cash flows.

Rising asset prices in turn improve financing conditions. Property provides stronger collateral. Higher share prices make equity issuance easier. Company valuations allow new loans on better terms. Even weak firms can suddenly look more solid because their assets and collateral are valued more highly. The market sees a larger buffer, although the company’s operating core has not necessarily strengthened.

The cycle closes: cheap credit drives valuations up. Higher valuations improve collateral and creditworthiness. Better creditworthiness enables further refinancing. That refinancing keeps companies alive which, under tougher capital costs, would shrink, be sold or be wound up. A zombie does not emerge overnight. It emerges when the next extension is always cheaper than correction.

A zombie company is not simply a weak company. Weakness is part of the market. Research, too, has no completely uniform definition. In a broad measure, the Bank for International Settlements includes older companies whose operating profits have been insufficient to cover interest costs for at least three years. A narrower measure also considers weak earnings expectations. The decisive issue is thus not one bad year, but lasting dependence on follow-on financing despite a lack of viability.

This is where the damage to the wider economy lies. Zombie companies tie up capital that more productive firms could use. They tie up labour needed in growing business models. They absorb management capacity, bank lending, supplier relationships and attention. At normal interest rates, they would have to decide: close divisions, sell assets, release staff and capital, merge with competitors or fail. The process is unpleasant, but it clears space.

The Austrian school describes this as a problem of economic calculation. Prices are not market decorations but information signals. They indicate scarcity, alternatives and opportunity costs. Interest is a central price in this order because it coordinates the capital structure over time. Distorting it does more than cheapen loans. It shifts the entire assessment of which production paths are sustainable.

This particularly affects capital-intensive and long-term projects. The further in the future returns lie, the stronger the discount rate’s effect. An artificially low rate therefore encourages not only more investment but a different kind: longer, more sensitive structures more dependent on financing. While the interest-rate environment persists, that can look stable. Once capital is priced as scarcer again, it becomes clear which projects worked only in an artificially cheapened future.

Here the hard budget constraint matters. In a functioning market economy, it forces companies to choose. Which projects truly cover their capital costs? Which investments earn more than they consume? Which divisions deserve capital, and which merely hold resources captive? Interest makes these questions measurable. It is not the only yardstick, but without it calculation loses its edge.

Zero interest softens that constraint. Losses are not punished immediately because refinancing stays cheap. Debt loses its disciplinary character as its ongoing cost falls. Banks and investors can hope the next refinancing round will suffice. Companies face less pressure to decide clearly which mistakes must end. Insolvency is not abolished, but postponed. Market selection becomes a holding pattern.

The Keynesian counterargument deserves a fair presentation. In acute crises, low interest can stabilise demand, ease liquidity shortages and prevent a temporary shock from triggering a deflationary spiral. If companies would fail only because markets briefly freeze, cheap liquidity can provide a bridge. This argument opposes panic; it does not advocate permanently funding unproductive structures.

The conflict starts when the bridge becomes permanent. A crisis measure is meant to buy time. Permanent low-rate policy, by contrast, changes selection. It rewards not just survival in an emergency but business models based on cheap refinancing. It stabilises demand while also preserving misallocations. It prevents collapses while weakening pressure to reorganise capital.

That is precisely why zero interest is politically attractive and economically risky. It eases visible pain: fewer insolvencies, fewer redundancies, fewer recognised losses. The invisible costs arise later and spread more widely. Productive businesses find fewer resources. New competitors encounter markets where old suppliers do not disappear. Capital markets become accustomed to valuations difficult to maintain without artificially cheap money. The economy looks calmer, but learns less effectively.

Zombie companies are therefore no marginal bookkeeping phenomenon. They are a symptom of a distorted capital order. Manipulating the price of time changes which future gets financed. The market does not stop calculating. It simply calculates with a false signal.

A clean exit is politically uncomfortable because it cannot come without losses. Hard budget constraints make mistakes visible. Higher capital costs render some projects unviable. Normalised interest requires asset prices, collateral and business models to be reassessed. Without that test, however, it remains unclear which companies create value and which merely organise refinancing.

Zero interest does more than save companies. It changes which mistakes continue to be financed.