Mercatus interest rate colloquium
The Mercatus Center has a new colloquium on the issue of low interest rates. There will be a series of 12 essays discussing the causes and consequences of low rates, as well as the outlook for the future. The papers will be released one at a time between now and mid-December. David Beckworth has the first post—here is an excerpt:
On the basis of regression of the two series in figure 5, the risk-free real interest rate should return to 1.65 percent once the output gap reaches zero. If one assumes that this estimated relationship holds up, then the only other drag on the 10-year Treasury is the term premium. As figure 2 shows, the term premium has plummeted since 2013. Why has it fallen so sharply?
There are several answers. New regulations requiring financial firms to hold a greater amount of safe assets have increased the demand for long-term Treasury bonds. The aging of populations in advanced economies has also increased the demand for long-term Treasury securities. Large-scale asset purchases by central banks may also be a factor. Additionally, both ongoing policy uncertainty caused by Brexit and the rise of populist political forces raise the demand for safe assets.
Read the whole thing.
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30. November 2016 at 05:52
I read the Beckworth post. Conceptually, it’s interesting, but the concepts seem too soft. Posts you’ve made in the past about the difficulties of measuring inflation apply here too. And a Term Premium is logical, but since it changes and can be negative, it just highlights more conceptual uncertainty in predicting future 10 year interest rates. Lastly, and most importantly, the prediction that 10 year interest rates will rise but with no timeframe is useless. Useless but honest in a way since the nominal 10 year rate is shown to have 3 components, each of which is unpredictable itself.
30. November 2016 at 07:32
A simpler explanation of low interest rates is simply fashion. Recall back in the 19th century a long-term gilt had a 3-4% interest rate which was considered adequate compensation. So aside from the post-WWII and war-time inflation periods, it seems 3-4% is adequate compensation when inflation is low. Personally, I think we’ll have inflation return when the billions in Africa and India come online and demand a Western lifestyle (without the beef maybe) and resources get depleted.
30. November 2016 at 08:36
I blame the Hummphrey-Hawkins Act of 1978.
30. November 2016 at 09:51
For one the Fed has rates set low at the short end. The long end will follow that, unless there is really good reason not to.
When the short rate is low, then everyone plugs that new rate into their forward pricing formulas, and don’t need to raise prices as much to exceed the risk free rate over their time frame.
30. November 2016 at 11:14
Can you throw bigger government in as a cause and an effect of low interest? On the one hand you’ve got regulators pressuring banks into holding government bonds and on the other hand you’ve got the Fed buying up bonds to meet an inflation target. I would think both serve to reduce yield on government bonds all else being equal. And I would expect that would in turn stimulate more movement of the government’s dead hand.
30. November 2016 at 11:19
I don’t think that’s right, Matthew. Although it’s true that a lower short end could push down expected future rates over the next, say, year, it should pull up on the long end provided that it actually constitutes “easy money.” The question is whether interest rates are low because the Fed wants to stabilize NGDP or because it has failed to do so. I don’t think the Fed can “set” rates over any material time horizon.
30. November 2016 at 11:20
There is no great mystery behind the term premium…it closely follows expected bond volatility (the MOVE index for example). The more Fed (or other) actions decrease bond volatility the lower your term premium…i fully expect when (if) the Fed starts to shrink it’s balance sheet, bond volatility will increase again (and the term premium with it).
30. November 2016 at 11:42
Bill, Yes, this stuff is very difficult to measure and forecast.
Ray, You said:
“billions in Africa and India come online and demand a Western lifestyle”
That’s the loony Ray we all know and love.
Carl, I’d say bad supply side polices by the government can slow growth and lower real yields. Fed bond purchases might do what you say, but in the long run they may actually raise yields if they boost inflation expectations.
2. December 2016 at 18:57
I have two things:
1. There was a question about why interest rates rose. My first thought was higher inflation due to deficit spending. But based on Beckworth’s article, the term premium may have also gone down significantly assuming lower capital requirements and safe asset holding in the future.
2. How does the Mercatus center make such good-looking graphs?
4. December 2016 at 09:53
Matthew, You’ll have to ask David about the graphs.