Nick Rowe has a post discussing 30 year bond yields in Canada. He begins by quoting from an official at the Bank of Canada:
All told, we think that the neutral rate of interest is lower than it was in the years leading up to the crisis because of these structural developments. We estimate that the real neutral policy rate is currently in the range of 1 to 2 per cent. This translates into a nominal neutral policy rate of 3 to 4 per cent, down from a range of 4 1/2 to 5 1/2 per cent in the period prior to the crisis.
Then Nick comments:
But what puzzles me is this: the 30-year bond is currently yielding 2.74%. That’s below Carolyn’s 3% to 4%. And Carolyn is talking about the Bank of Canada’s target for the overnight rate (the “policy rate”), and that’s normally below the 30-year bond yield.
I checked the 30-year rate in Germany and the US:
US 30-year bond yield = 3.21%
German 30-year bond yield = 1.91%
So it’s a sort of global mystery. Why are long-term interest rates so low?
But it’s not the only big global mystery. There’s also the absurdly slow “recovery” from the 2008-09 recession. This is the only recovery I ever recall seeing where the growth rate of real GDP in the US was below the trend growth rate. And nominal GDP growth has also been very low. Indeed both growth rates might well be the lowest in American history for a recovery period.
And it’s not just the US. Some countries like Canada may have done a bit better, but lots of countries in Europe are seeing even slower recoveries in both NGDP and RGDP.
I am always suspicious of coincidences. I suppose you could dream up an explanation for the low bond yields. Maybe all that QE has depressed long term bond yields. Maybe I am wrong that money has been really tight; maybe it’s really easy, and that explains the low bond yields.
But there’s one problem with that explanation–it makes the other mystery even more mysterious. How likely is it that money has been so easy that it has produced almost unbelievably low bond yields, and yet NGDP is growing at the slowest rates ever seen in a recovery? Easy money is supposed to lead to fast NGDP growth. I don’t like “answers” that solve one mystery at the expense of making another mystery even more mysterious. [There's no law of the conservation of net mysteriousness.] I like “answers” that solve both mysteries at the same time, using standard off-the-shelf economic theory.
The Great Stagnation!
It explains the low bond yields, and it explains the slow economic growth despite rapidly falling unemployment rates. But what explains the differences in bond yields between countries? Here I’d like some help, but I’ll throw out a couple tentative hypotheses. Although both the US and Canada have 2% inflation targets, I recall reading that the US is more aggressive in the “hedonics” of price adjustments. Indeed one Fed official said their 2% PCE target is actually more like a 2.4% CPI inflation target. Is that right? If so, might that explain why Canada has lower bond yields? If both countries have 2% inflation targets, but Canada measures inflation more conservatively, then Canada would end up with lower NGDP growth, other things equal.
In the case of Germany, it might be related to the fact that the ECB is targeting inflation at slightly below 2%, an asymmetric target. In addition, inflation has recently fallen to only 0.3%, and the ECB’s response — how can I put this politely — hasn’t exactly inspired confidence.
So perhaps the entire developed world is entering the sort of growth stagnation that hit Japan 20 years ago, producing low real interest rates everywhere. Then the differences in bond yields reflect differences in the techniques used to measure inflation, differences in inflation targets (especially the ECB), and differences in how confident investors are that the central bank will actually hit its target (the ECB and Japan.)
I’m glad to see the BOC re-evaluate their interest rate assumptions, but the markets suggest they are still behind the curve. Of course the Fed has consistently overestimated the Wicksellian equilibrium interest rate, and hence over-estimated RGDP growth, ever since 2007. And the ECB? There aren’t any words to express my contempt for that organization.
We’re 15 years into the 21st century. How much longer will it take the world’s central bankers to realize that we aren’t in Kansas anymore? None of the 20th century rules of thumb have any value in today’s world.