Paul Krugman says there's reason to doubt the common wisdom that a "safe asset shortage" is the primary reason for low interest rates (i.e. that high demand is driving up the price of safe assets and driving down the rate of return):
Safety Second (Wonkish), by Paul Krugman: The “safe asset shortage” meme has been gathering force lately, and is now the theme of a report from the IMF (pdf). The idea is that low long-term interest rates for the United States, the UK, and basically every country with its own currency that doesn’t have large foreign-currency debts reflect the desperate search of investors for something safe to buy.
So, can I express some skepticism? I don’t think this is wrong, exactly, but I suspect that the search for safety is a distinctly secondary factor here. Surely the main point is that the major economies seem likely to remain depressed for a long time, and that as a result short-term interest rates are likely to stay low for a long time too — which means that long rates, which largely reflect expected short rates, are low right now.
Consider, as you always should in these times, the example of Japan. Here’s 15 years of 10-year interest rates... That's an extraordinarily low rate for a very long time — a low rate that persisted, by the way, despite downgrades from rating agencies and a more or less continual flow of claims that Japanese debt problems were going to come home to roost any day now. So what explains this? Safe assets didn’t seem to be in short supply in, say, 2005, when investors believed in the virtues of toxic waste. But the key point about Japan is that anyone who bought and held those bonds made money...
I guess my point is that the “safe asset” meme seems to imply that there’s some kind of market aberration in the high prices (and low yields) of bonds, that investors are willing to lose money because they’re frightened. But most of what we’re seeing just reflects a perceived lack of good investment opportunities.
Brad DeLong replies:
I would note that equities do not seem to be selling at extraordinarily high earnings multiples now--which is what we would expect to see if the root problem were just a shortage of good investment opportunities. When there is a shortage of good investment opportunities--an excess demand for savings vehicles, ex ante full-employment savings greater than ex-ante full-employment investment in the Wicksellian-Keynesian-Hicksian framework--interest rates and earnings yields tend to all be unusually low. Today it is just interest rates on assets perceived as safe that are unusually low. And boy are they unusually low!