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Wednesday, March 05, 2014

'Global Interest Rates and Growth (r-g)'

Antonio Fatas looks at the relationship between growth and intereest rates:

Global interest rates and growth (r-g): The difference between interest rate and growth rates appears as an important parameter in many macroeconomic models. It is also a key variable to assess the sustainability of public finances: higher interest rates make the cost of carrying over debt higher while high growth rates help keep the debt to GDP ratio under control.

In a recent post Floyd Norris criticizes the assumptions used by the US Congressional Budget Office for its fiscal projections because they are assuming lower growth rates ahead but a return to "normal" interest rates. The point that Norris makes is that we tend to think that interest rates and growth rates are correlated, so if growth is going to be much lower going forward we should also forecast lower interest rates (and this will make the fiscal outlook look more positive).

Paul Krugman initially supports Floyd Norris' arguments but later, after checking the data, he realizes that growth and interest rates are not that correlated. ...
But ... Norris and Krugman are looking at interest rates and growth in the context of one economy (the US)..., given the global nature of capital markets the relationship between interest rates and growth (if any) should only be present at the global level. What happens if we look at the  differential between interest rates and growth for the world? ...
As in the US data, the relationship between interest rates and growth rates has varied over the past decades. ...
In summary, given that interest rates are determined by global conditions, anything could happen when comparing them to growth rates for a given country (of course if the country is large enough to influence global variables then national and global conditions are correlated). The right way to look at these two variables is at the world level. But the empirical evidence confirms that, even if we look at a global level, one cannot rule out future scenarios of movements in interest rates and growth rates in opposite directions (they still need to be justified in terms of the global dynamics of investment and saving, but they are possible).

[I left out his supporting evidence.]

    Posted by on Wednesday, March 5, 2014 at 09:38 AM in Economics | Permalink  Comments (18)


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