CAMBRIDGE – A day seldom passes without articles appearing in the financial press pondering why interest rates have remained so low for so long. This is one of those articles. So let’s start by clarifying whose and which interest rates are low and what is and isn’t novel or unprecedented.
Interest rates in emerging and developing countries are importantly affected by what happens in the world’s largest economies, and the ongoing multi-year low-interest-rate cycle has its roots in the United States, Europe, and Japan. Low rates are predominantly the advanced economies’ “new normal.”
Interest rates (short and long maturities) had been trending lower in most of the advanced economies (to varying degrees) since the 1980s, as inflation also fell sharply. In the years prior to the 2008-2009 financial crisis, former US Federal Reserve Chairman Ben Bernanke repeatedly stressed the role of a global “saving glut” (notably in China) to explain lower rates.
More recently, former US Treasury Secretary Lawrence Summers argued that “secular stagnation,” manifested in sustained lower investment and growth in many advanced economies, has been a major force driving down rates. These hypotheses (which are not mutually exclusive) are especially helpful in understanding both why rates were drifting lower prior to the crisis and why the downturn has persisted.
The financial crisis ushered in a new source of downward pressure on interest rates, as monetary policy turned emphatically accommodative. The US Federal Reserve led the charge among central banks, acting fast and aggressively in response to the global turmoil, by relying on a near-zero policy rate and massive asset purchases (so-called quantitative easing). In the post-crisis era, the Bank of Japan and the European Central Bank – both under new leadership – followed suit. Negative nominal policy interest rates are a more recent phase of these policies.
Since 2010, I have been emphasizing the key role played by policy in keeping rates low in a post-crisis era characterized by large overhangs of public and private debt in the advanced economies and a tendency toward deflation. This combination potentially weakens financial, household, and government balance sheets.
In other words, interest rates have been low, and remain low, because policymakers have gone to great lengths to keep them there. The policy mix has combined a “whatever it takes” approach to keeping policy interest rates low (and sometimes negative) with a heavier dose of financial regulation.
If central banks were to act credibly to raise interest rates substantially (for whatever reason), they would not lack the tools or ability to do so. In this unlikely scenario, market expectations would adjust accordingly and rates would rise (saving glut and secular stagnation notwithstanding).
The behavior of real (inflation-adjusted) interest rates helps clarify the role of the post-crisis monetary-policy shift. As shown in the figure below, which plots the share of advanced economies with negative long-term interest rates (ten-year treasuries yielding less than the rate of inflation) from 1900 to 2016. In the run-up to the crisis, there are no recorded negative real returns on government bonds; since the crisis, the incidence of negative returns increases and has remained high. Of course, the share of countries with negative short-term treasuries (not shown here) is even higher since 2009.
But the figure also 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.
In an era when public debt write-offs (haircuts) are widely viewed as unacceptable (witness the European Union’s position on Greece) and governments are often reluctant to write off private debts (witness Italy’s reluctance to impose a haircut on holders of banks’ subordinated debt), sustained negative ex post returns are the slow-burn path to reducing debt. Absent a surprise inflation spurt, this will be a long process.
Comments
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Comment Commented M M
Central Bankers initiatives such as QE, negative interest rates, etc. are like injecting steroids into a dead corpse. What is needed to create growth and stimulate the real economies is well known, all it requires is courage and a courageous / honest person. Read more
Comment Commented G. A. Pakela
What a great analogy! Apparently, Professor Reinhart believes that negative policy rates - charging banks for holding reserves, will stimulate more lending. The opposite has shown to be the case. Negative rates simply harm banks and everyone that has traditionally relied on positive interest rates. Central banks cannot force individuals and businesses to borrow, and their efforts may be doing the opposite. Read more
Comment Commented G. A. Pakela
The demographics of the baby boom explain more of today's low growth, low inflationary environment than traditional economic theory. This generation has driven labor force growth and demand for decades. They have completed this process and are exiting the workforce. Their children and grandchildren are waiting longer to get married and are having fewer children. The impetus for growth lies with increasing productivity and technological change. However, the latter may be reducing demand because much of it is centered around social networking and is thus free to consume. Read more
Comment Commented Kenneth Pao
Thank you, Professor Reinhart, for this illuminating article about prolonged period of low interest rates in the past. So, have no fear. This low interest rate period is going to last for quite some time until inflation kicks up ... Meanwhile all the retirees on fixed income depending on bonds income are doomed ... Read more
Comment Commented yw yap
YES! Guess the $million dollar Question is WHEN? Read more
Comment Commented Colin Doyle
A more common sense argument is that low interest rates are themselves a major contribution to deflation.
Firstly, when rates are so low, banks lend less; they are more risk averse because it's more difficult to make profits from lending.
Secondly, savers don't spend the interest they don't receive.
Thirdly, in difficult times borrowers pay down debt rather than borrow more.
It all means that lower, even lower and then negative rates are a vicious spiral only going down. There is no tried, or even theoretically apparent, route to economic growth from negative interest rates.
Instead the 'surprise inflation spurt', which Ms Reinhart adds as a reserve in the last line of her articlet, would come from (moderate*) quantitative easing for the people in the shape of tax cuts funded by central banks printing money. Then we could have a return to around 5% interest on safely invested retirement savings, while the general economy is also pushed up by substantial increases in minimum wages. Wouldn't that be so nice?
*Koichi Hamada agues in his article from April, that :
"no MFFP proposal even recognizes this tendency (to overprint money), much less includes provisions to avoid it". He cannot have looked at the current proposals. The ones I have seen all include the idea of an independent agent to decide how much money to print - like a Money Commission. See, for example: http://www.youtube.com/user/PositiveMoneyUK Read more
Comment Commented Michael Muoio
Shadow rates have been as low as 300 bps and infant the Fed has raised ~300Bps since 2014. We are however in blue water and no one really know what the hell is going on. But we do know this, financial repression forces irrational financial decisions that surely will not end well. In light of our collective ignorance on the subject, I would suggest we return to the long term normative rate ~3-4% and have all the central banker go on a long fishing trio to Argentina. The behavioral damage to the economy by these elites has been enormous and will never produce recovery as savings rates will continue to soar as planning for retirement morphs into planning for a new job post retirement. Read more
Comment Commented yw yap
Guess irrational fin decisions by these elites will bring us to newfound land, if there's one. Read more
Comment Commented David Olsen
Negative interest rates emanate from Europe. There is a search for asset classes that generate some kind of a return and in lieu of that an asset class that will preserve capital.
The reason that there is a lack of opportunities for investors to make money is that aggregate demand is seriously deficient in Europe.
Solve the aggregate demand problem before embarking on financial repression. The ECB can print all the Euros it wants to back European govt debt, if it was allowed to by the Germans. There is no reason European public debt and govt spending cannot compensate for the lack of spending by indebted private businesses and consumers. No reason except for the Calvinistic mentality of the German controllers of the Euro.
Put the blame where it belongs. There is no mystery as to why interest rates are low.
German savers will continue to suffer until the German govt allows sufficient fiscal spending within the Eurozone to compensate for the lack of spending by European business and consumers.
The disease is spreading and the Europeans are now killing off demand worldwide.
Articles like this just cloud the issue and give excuses for European elite stupidity. There are political consequences from austerity as there have been in the past. The 1920's gilded age and the widening of the income gap was followed by the depression which was followed by austerity and budget balancing leading to further unemployment and poverty which lead to the rise of Fascism which led to WWII.
French insistence on the repayment of WWI German debt/reparations led directly to the impoverishment and embittering of Germany and the rise of Hitler. There is a guy who believed in infrastructure spending. There is a reason why he was popular at the start - he pulled Germany out of depression. Shame about the rest of his agenda.
Can we really not learn anything from the past?
The positions are now reversed. It is the Germans who are carrying out the financial repression on their neighbors.
This can't end well, this won't end well.
The British are well out of it.
Read more
Comment Commented Doug Huggins
Reinhart writes, " ...taxing banks that hold reserves (negative-interest-rate policy) will also encourage more bank lending, and thus stimulate growth." While this seems intuitive, it appears not to be the case in the current environment. Many of the largest banks are actively turning away deposits of various sorts (eg, non-operating corporate deposits), because the current rate structure and new regulations make intermediating those deposits unprofitable. Read more
Comment Commented prashanth kamath
Up is down, down is up! Read more
Comment Commented ROHIT CHANDAVARKER
The interest rate policy is dependent on the economic scenario & economic growth. Central banks across Europe & Japan have resorted to negative interest rates primarily to kick start a moribund economy. Real inflation is unexceptionally low & depressed demand has deterred private & public investment. This vicious cycle is likely to hit US with Fed Chairperson Yellen hinting at possibility of negative interest rate scenario in the near future. The new normal has resulted in concomitant damage to social fabric in many countries. The situation remains bleak due to the fact that China is hurting while it possesses huge forex reserves accumulated during the irrational exuberance witnessed pre-2008. The Chinese economy boomed with money gushing in from all corners. Today the world is suffering from those excesses. Excess capacity remains a big problem thus dissuading fresh investments. The Western economies suffer from low productivity, high wages, social security burden & overall lethargy. The US may signal green shoots cropping up but would make little difference as the Fed seems clueless about the future course of action. This is hardly its mistake as diametrically opposite data points seem to have made its task tough & onerous. Disruption is the new normal & is vexing the mind of every policy maker world over. Read more
Comment Commented david b
taxing banks that hold reserves (negative-interest-rate policy) will also encourage more bank lending, and thus stimulate growth.
Can you prove the above is true beyond theory with real empirical data. There should be enough by now. I doubt you can. I think it wa stiglitz in these pages that was saying it wasn't happening. Read more
Comment Commented david b
The central bank, however, said it will conduct a thorough assessment of the effects of negative interest rates and its massive asset-buying programme, suggesting that a major overhaul of its stimulus programme may be forthcoming. Read more
Comment Commented david b
taxing banks that hold reserves (negative-interest-rate policy) will also encourage more bank lending, and thus stimulate growth.
http://fortune.com/2016/07/29/bank-of-japan-stimulus-expand-interest-rates-brexit/
So if the BOJ is doing the above I'd argue the benefits aren't so clear Read more
Comment Commented Michael Public
In other words the so called free-market economies are fixing interest rates. Read more
Comment Commented Steve Hurst
@Micheal
Its an attempt to competitively devalue currency but not working due to world trade falling and folks parking money Read more
Comment Commented Steve Hurst
Lets face it few would put money into negative interest rates if it was felt there were good returns elsewhere, so the problem is elsewhere not with CBs. CBs are offering security so risk-reward has broken down elsewhere
There is no reason to believe negative rates will encourage lending unless risk-reward is seen as beneficial. Therefore negative rates are implemented for other reasons
Read more
Comment Commented Jamel Saadaoui
Thank you for this post, I wonder whether we will need to adopt more formal measures to implement financial repression.
In this perspective, capital controls and negative real rates could be a way to increase global financial stability.
Best,
Jamel Saadaoui Read more
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