low interest rates

Nominal interest rates on secure debt, such as long-term government bonds, are now very low, even zero or negative in some countries. Economists prefer to look at real interest rates (nominal rates less inflation), which are more informative. After all, nominal rates might be very high, but if inflation is even higher, the return is negative for those who purchase bonds.

Cuban-American economist Carmen Reinhart looks at real interest rates in advanced economies over time, and finds that bouts of negative real rates have been common for more than a century. What is novel is deflation (falling prices), which requires negative nominal rates to produce the negative real rates central banks seek in order to stimulate growth.

[The chart below] shows that the 2010-2016 period is not the first episode of widespread negative real returns on bonds. The periods around World War I and World War II are routinely overlooked in discussions that focus on deregulation of capital markets since the 1980s. As in the past, during and after financial crises and wars, central banks increasingly resort to a form of “taxation” that helps liquidate the huge public- and private-debt overhang and eases the burden of servicing that debt.

Such policies, known as financial repression, usually involve a strong connection between the government, the central bank, and the financial sector. Today, this means consistent negative real interest rates – equivalent to an opaque tax on bondholders and on savers more generally.

So if a prolonged period of low and often negative real interest rates is not unprecedented, where is the novelty? More often than not, negative real rates were accompanied by higher inflation (as during the wars and the 1970s) than what we observe today in the advanced economies. Even when average inflation was modest (as in the 1950s and 1960s), it was still more volatile.

In the 1930s, in the midst of economic depression and sharp deflation, US Treasury bills sometimes traded at negative yields (and real returns were still positive). In today’s low-inflation or outright deflationary environment, central banks may need negative policy rates (this is the novelty part) to produce negative real rates. In the eurozone and Japan, taxing banks that hold reserves (negative-interest-rate policy) will also encourage more bank lending, and thus stimulate growth.

Carmen Reinhart, “What’s New About Today’s Low Interest Rates?“, Project Syndicate, 28 July 2016.

There is much more in the full column. Carmen M. Reinhart (née Castellanos, 1955) is on the faculty of the Harvard Kennedy School. She co-authored (with Kenneth Rogoff) This Time is Different: Eight Centuries of Financial Folly, published by Princeton University Press in 2009.

advanced economies with negative long-term interest rates

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