Low Real Interest Rates: Depression Economics, Not Secular Trends

Gene Kindberg-Hanlon at Bank Underground:

Low real interest rates: depression economics, not secular trends: Real interest rates have fallen by around 5 percentage points since the 1980s. Many economists attribute this to “secular” trends such as a structural slowdown in global growth, changing demographics and a fall in the relative price of capital goods which will hold equilibrium rates low for a decade or more (Eggertsson et al., Summers, Rachel and Smith, and IMF). In this blog post, I argue this explanation is wrong because it’s at odds with pre-1980s experience. The 1980s were the anomaly (chart A). The decline in real rates over the 1990s and early 2000s simply reflected a return to historical norms from an unusually high starting point. Further falls since 2008 are far more plausibly related to the financial crisis than secular trends.

Chart A: US 1 year real interest rates since 1900

Source: Robert Shiller and author’s calculations
Note: Simple estimate of real rates using 1-year US treasury bill converted to a real yield using the year-ahead CPI outturn. Model-based estimates of short and long-term real interest rates show similar trends to the above chart (for example, see IMF).

Do secular trends affecting real interest rates fit the data before the 1980s?

Studies proposing a secular fall in real interest rates have generally taken the 1980s as their starting point. However, the 1980s appear to be an anomaly, as real interest rates were well above rates observed earlier in the 20^th century. The secular trends proposed to be causing declining real rates since the 1980s do not fit the data beforehand. ...

... It would not be the first time that economists had fallen into the trap of assuming growth and interest rates would remain permanently lower for longer as a result of secular trends following a large financial crisis. In the late 1930s, Alvin Hansen developed the term “secular stagnation” to describe his concerns that structural factors such as stagnant technological development and weaker population growth prospects would weigh on growth permanently. We know now that these concerns over secular trends proved misplaced, and played little role in weaker growth. But there is large uncertainty over the length and depth of the slowdown in growth following a broad-based financial crisis of the severity seen in 2008. The Great Depression was only ended by rearmament and war, but other financial crises have seen recoveries at or before the 10-year mark. Are we now at a point in which the effects of the 2008 crisis on interest rates may begin to wear off?