Why Are Real Interest Rates So Low, and Will They Ever Bounce Back?

In his recent post commenting on the op-ed piece in the Wall Street Journal by Michael Woodford and Frederic Mishkin on nominal GDP level targeting (hereinafter NGDPLT), Scott Sumner made the following observation.

I would add that Woodford’s preferred interest rate policy instrument is also obsolete.  In the next recession, and probably the one after that, interest rates will again fall to zero.  Indeed the only real suspense is whether they’ll be able to rise significantly above zero before the next recession hits.  In the US in 1937, Japan in 2001, and the eurozone in 2011, rates had barely nudged above zero before the next recession hit. Ryan Avent has an excellent post discussing this issue.

Perhaps I am misinterpreting him, but Scott seems to think that the decline in real interest rates reflects some fundamental change in the economy since approximately the start of the 21st century. Current low real rates, below zero on US Treasuries well up the yield curve. The real rate is unobservable, but it is related to (but not identical with) the yield on TIPS which are now negative up to 10-year maturities. The fall in real rates partly reflects the cyclical tendency for the expected rate of return on new investment to fall in recessions, but real interest rates were falling even before the downturn started in 2007.

In this post, at any rate, Scott doesn’t explain why the real rate of return on investment is falling. In the General Theory, Keynes speculated about the possibility that after the great industrialization of the 19th and early 20th centuries, new opportunities for investment were becoming exhausted. Alvin Hansen, an early American convert to Keynesianism, developed this idea into what he called the secular-stagnation hypothesis, a hypothesis suggesting that, after World War II, even with very low interest rates, the US economy was likely to relapse into depression. The postwar boom seemed to disprove Hansen’s idea, which became a kind of historical curiosity, if not an embarrassment. I wonder if Scott thinks that Keynes and Hansen were just about a half-century ahead of their time, or does he have some other reason in mind for why he thinks that real interest rates are destined to be very low?

One possibility, which, in a sense, is the optimistic take on our current predicament, is that low real interest rates are the result of bad monetary policy, the obstacle to an economic expansion that, in the usual course of events, would raise real interest rates back to more “normal” levels. There are two problems with this interpretation. First, the decline in real interest rates began in the last decade well before the 2007-09 downturn. Second, why does Scott, evidently accepting Ryan Avent’s pessimistic assessment of the life-expectancy of the current recovery notwithstanding rapidly increasing support for NGDPLT, anticipate a relapse into recession before the recovery raises real interest rates above their current near-zero levels? Whatever the explanation, I look forward to hearing more from Scott about all this.

But in the meantime, here are some thoughts of my own about our low real interest rates.

First, it can’t be emphasized too strongly that low real interest rates are not caused by Fed “intervention” in the market. The Fed can buy up all the Treasuries it wants to, but doing so could not force down interest rates if those low interest rates were inconsistent with expected rates of return on investment and the marginal rate of time preference of households. Despite low real interest rates, consumers are not rushing to borrow money at low rates to increase present consumption, nor are businesses rushing to take advantage of low real interest rates to undertake shiny new investment projects. Current low interest rates are a reflection of the expectations of the public about their opportunities for trade-offs between current and future consumption and between current and future production and their expectations about future price levels and interest rates. It is not the Fed that is punishing savers, as the editorial page of the Wall Street Journal constantly alleges. Rather, it is the distilled wisdom of market participants that is determining how much any individual should be rewarded for the act of abstaining from current consumption. Unfortunately, there is so little demand for resources to be used to increase future output, the act of abstaining from current consumption contributes essentially nothing, at the margin, to the increase of future output, which is why the market is now offering next to no reward for a marginal abstention from current consumption.

Second, interest rates reflect the expectations of businesses and investors about the profitability of investing in new capital, and the expectations of households about their future incomes (largely dependent on expectations about future employment). These expectations – about profitability and about future incomes — are distinct, but they are clearly interdependent. If businesses are optimistic about the profitability of future investment, households are likely to be optimistic about future incomes. If households are pessimistic about future incomes, businesses are unlikely to expect investments in new capital to be profitable. If real interest rates are stuck at zero, it suggests that businesses and households are stuck in a mutually reinforcing cycle of pessimistic expectations — households about future income and employment and businesses about the profitability of investing in new capital. Expectations, as I have said before, are fundamental. Low interest rates and secular stagnation need not be the result of an inevitable drying up of investment opportunities; they may be the result of a vicious cycle of mutually reinforcing pessimism by households and businesses.

The simple Keynesian model — at least the Keynesian-cross version of intro textbooks or even the IS-LM version of intermediate textbooks – generally holds expectations constant. But in fact, it is through the adjustment of expectations that full-employment equilibrium is reached. For fiscal or monetary policy to work, they must alter expectations. Conventional calculations of spending or tax multipliers, which implicitly hold expectations constant, miss the point, which is to alter expectations.

Similarly, as I have tried to suggest in my previous two posts, what Friedman called the natural rate of unemployment may itself depend on expectations. A change in monetary policy may alter expectations in a manner that reduces the natural rate. A straightforward application of the natural-rate model leads some to dismiss a reduction in unemployment associated with a small increase in the rate of inflation as inefficient, because the increase in employment results from workers being misled into accepting jobs that will turn out to pay workers a lower real wage than they had expected. But even if that is so, the increase in employment may still be welfare-increasing, because the employment of each worker improves the chances that another worker will become employed. The social benefit of employment may be greater than the private benefit. In that case, the apparent anomaly (from the standpoint of the natural-rate hypothesis) that measurements of social well-being seem to be greatest when employment is maximized actually make perfectly good sense.

In an upcoming post, I hope to explore some other possible explanations for low real interest rates.


31 Responses to “Why Are Real Interest Rates So Low, and Will They Ever Bounce Back?”

  1. 1 Frank Restly January 9, 2013 at 9:52 pm


    “In an upcoming post, I hope to explore some other possible explanations for low real interest rates.”

    While you are looking for possible explanations for low real interest rates you might consider looking at where credit originates within an economy – does it fund consumption in excess of production or vice versa.


  2. 2 Benjamin Cole January 10, 2013 at 12:31 am

    This is a fascinating post, and I think David G. is wending his way to some of the key economic questions of our era. I hope he pursues. I want to learn myself by reading David G.

    Here are some inchoate thoughts:

    1. Why such low interest rates, and why does Sumner think they will stay low?

    Well, look at sovereign yields for the last 20 years. They are trending to zero bound. This is a secular trend. And once they get to zero, they cannot go lower, so it is reasonable they will go to zero…and stay there. Japan never got out of zero.

    Once Economy Grandma slips on the Zero Bound Ice, how do we get her back up? Friedman said print money to the moon. I think he was right, but can central banks shuck off their encrusted self-exalting mindsets and do it?

    2. Global savings glut. Suppose people save, regardless of interest rate. For security, for college, for retirement, to start a business, or because they make so much money even if they spend a lot, they still have gobs left over. For the first time in history, the globe is creating many large middle-class or above nations, and even some nations that are barely middle class have huge upper classes that save (think China, India).

    For all of history, capital was scarce–we spend every penny surviving. Not now. Now capital is abundant. Of course, interest rates would be lower in such a scenario. And that scenario is the current reality. BTW, in just USA savings deposits, another $3-4 trillion has piled in since 2008.

    3. Maybe we are in deflation, and so interest rates are not so low. Really, measuring inflation is tricky. We now have rapid evolution of goods and services, and rapid migration of businesses and consumers, globally, to best products and services.

    Crickey, what is a tablet (iPad) worth that has access to the world’s knowledge and entertainment through the web, and can be carried in your pocket? The new products are amazing, and meanwhile (in USA) home buying costs are at record lows.

    Take a few thousand digital pictures and send them across the globe in a minute. That would be a $20,000 bill 20 years ago. Now the marginal cost is zero.

    The PCE deflator is probably good to within -+2 percent. We might be in deflation now.

    4. Japan did try QE and low interest rates 2001-6. They still had deflation. So why is anyone sure in the USA we can get out of zero-bound and zero inflation, or very low for both?

    It may take 10 years of hard QE to get us out of this. Five did not work in Japan.

    5. Expectations? Well, I hope they work. My guess is the public does not trust any federal agency, least of all the Fed. Bankers have been pompously pontificating about inflation for eons,and Richard Fisher is running around in hysterics about inflation. I should trust the Fed to stick with a growth plan?

    Sumner is right to expect zero bound forever. I just hope Sumner is wrong.


  3. 3 Scott Sumner January 10, 2013 at 7:32 am

    David, You misinterpreted my views on several points:

    1. I don’t think falling real interest rates are a recent trend. Elsewhere I’ve argued that the real rate on 10 year T-bonds has been falling for at least 30 years, from about 7% in the early 1980s to negative today.

    2. The bond market expected real rates to rise in the future, as do I. But even if they do, nominal rates are likely to plunge right back to zero in the next recession. That’s because nominal rates almost always fall sharply during recessions, and they are likely to top out at about 3% before the next recession hits.

    Because real rates have been trending downward for 30 years or more, the cause cannot be tight money. Instead I’d blame higher Asian savings rates and bad demographics. These trends are likely to get even stronger in the future, so I see no reason why this declining trend in real rates would reverse anytime soon. Having said that, part of the recent decline in real rates is the effect of tight money on RGDP, and I’d expect that part to reverse as we recover. But the long term trend will remain in effect.


  4. 4 sumnerbentley January 10, 2013 at 7:33 am

    In my point two I meant “plunge right back below zero”


  5. 5 Diego Espinosa January 10, 2013 at 8:54 am

    Sometimes stagnation is accompanied by positive real rates (Japan), and sometimes by highly negative real rates (Latin America).

    If real rates are a function of investment projects in the economy, then by implication we are worse off than even Japan. This, despite our more robust recovery?

    Using TIPS, our expected r.r. is negative out ten years. Under “excessive pessimism”, this implies a persistent output gap. What would explain such persistence? Any theory would tell us that wages and prices would adjust downward in the long term– that we would experience outright deflation. This, in turn, would make l.t. expected real rates necessarily positive. Under the “pessimistic expectations” thesis, how is a negative expected l.t. real rate compatible given long term flexible wages/prices?

    Further, market indicators, aside from TIPS yields, are not flashing signals of abnormally low expectations. For instance, market P/E’s are in a normal historical range, as are non-financial high-yield spreads. Both the Fed and Blue Chip economists expect RGDP to grow moderately and the output gap to shrink. Further, we’ve seen a robust recovery in non-structures business investment. Surely this implies there is a normal set of investment projects available to CEO’s.

    Finally, since YE2009, as things got better, real rates have fallen, not risen. Under the “excessive pessimism” explanation, the opposite would be the case.

    What stands out about the U.S. economy is not deflation, a nominal shock, or abnormal pessimism in asset prices; instead, its just how sticky and on trend inflation expectations have been despite the crisis. I would look to this phenomenon to explain our real rates.


  6. 6 JP Koning January 10, 2013 at 9:40 am

    “The real rate is unobservable, but it is related to (but not identical with) the yield on TIPS which are now negative up to 10-year maturities.”

    This relates to a comment you made ages ago and a question I’ve been dying to ask:

    “So all you have to do is find an asset with no storage cost and no current service flow and calculate its expected rate of appreciation and you have the real natural rate of interest.”

    Given that this hypothetical asset has no service flow, would that mean that it can’t be traded and must be held perpetually? After all, highly liquid assets provide flows of “convenience services.” Illiquid ones don’t provide these same services. So the real rate could theoretically be found by observing the expected rate of appreciation of an asset that has no storage costs, that cannot be traded before expiring, and is risk free.

    As for the rest of the post, I like it and have no quibbles. Will refrain from commenting until a read the second post.


  7. 7 David Glasner January 10, 2013 at 7:41 pm

    Frank, Sorry, but your vice versa is ambiguous. Please be more explicit.

    Benjamin, Thanks for your kind words, but after that buildup, I am afraid that whatever I come up with will seem like an anticlimax. I tend to agree that the global savings glut (largely an Asian phenomenon) is part of the story. But the reasons for the sudden appearance of the savings glut are not so clear to me. The accumulation of savings deposits in the US that you mention seems more like a cyclical than a secular phenomenon. If you are right that we are in a deflation, then real interest rates are not as low as they seem and the economy is doing rather well. That seems inconsistent with high unemployment and high budget deficits, so that approach raises as many problems as it solves. Much as like Scott, I totally agree with your hope that he is wrong.

    Scott, Thanks for the clarification. I’m not sure that the early 1980s are a good benchmark for real interest rates. High real interest rates in the 1980s were a reflection of a liquidity squeeze by the Fed to wring inflation expectations out of the system. For much of the second half of the nineteenth century, long-term real rates were in the 2-3% range. So we are not exactly agreeing on what the long-term trend is. Also, short-term rates tend to be cyclically more sensitive than long-term rates, so it is not clear to me why long-term rates would go to zero because of a recession. That argument seems circular to me. I agree that monetary factors cannot easily explain zero long-term rates, but there may be some interaction between expectations of the future and monetary policy even if the connection is indirect. But I am thinking of something even more indirect, which, as I said, I am going to try to explain in an upcoming post (there I go building up expectations that I am unlikely to be able to meet, oh well.)

    Diego, You make a number of excellent points about the inconsistencies between the implications of different market indicators. However, to me that itself is a symptom of an underlying disequilibrium. Because markets are incomplete, the inconsistent expectations underlying different market prices cannot be arbitraged. Eventually the underlying expectations of some positions are going to be disappointed. We just don’t know whose.

    JP, There is an ambiguity in what the benchmark should be for a zero liquidity yield. You are tacitly assuming that the zero point is perfect illiquidity, and everything short of that receives a premium. But maybe the zero point is average liquidity and anything better than that receives a premium and anything worse bears a discount. Just a thought. Stay tuned.


  8. 8 Roman P. January 11, 2013 at 2:12 am


    You did a very insightful post! Inspired, I tried to look for papers that describe how the real interest rate is formed, but it turned out that there is no real consensus on the issue. Even more so for the Post Keynesian school where this question is central for a number of theories.

    One of the papers (Cottrell 1992, I believe) described an interesting theory that was first proposed by Marx and later adopted by a small number of the other heterodox economists: that the interest rate just has a conventional nature. I.e. that it is formed by the consensus between the capitalists, workers and financiers and reflects a share of total profits/surplus that goes to the owners of financial capital.

    I couldn’t judge how good this theory is, though. But I think that the theory of interest rate has to be connected with how the processes of (re)production and accumulation occur.


  9. 9 anon January 11, 2013 at 8:12 am

    “Because markets are incomplete, the inconsistent expectations underlying different market prices cannot be arbitraged.”

    This is an interesting point, but I’m not sure how important it is. Yes, it could be that expectations of interest rates are different between the T-bond and equity markets–but in that case, market agents would still tend to shift their portfolios out of Treasuries and into equities. To the extent they don’t, it may be because of a variety of reasons, such as Treasuries being valued for their use in transactions, or equities being seen as risky. So it’s not clear that inconsistent expectations are required after all: it may be a case of prices being affected by something other than expectations of the future.


  10. 10 Diego Espinosa January 11, 2013 at 12:43 pm

    The alternative explanation — that the Fed is holding down real rates through monetary policy — fits the data without having to make material exceptions to market completeness.

    I also think its important to grasp the level of incompleteness required by the “pessimistic expectations” thesis. According to that thesis, bond investors are saying, effectively, “on a risk-adjusted basis, the marginal 10yr investment project in the economy will have a negative real return.” This is quite a pessimistic statement! Imagine the barriers to arbitrage required to reconcile this view with the 14x P/E of the stock market, or the expectations for normal (albeit elevated) high yield defaults. I think it would imply some sort of major market malfunction. To my knowledge, spreads in the credit, equities and derivatives markets imply they are functioning normally.


  11. 11 Becky Hargrove January 11, 2013 at 12:59 pm

    Especially addressing Ryan Avent’s concerns with these thoughts as well: There needs to be a supply-side recognition of the growth incrementality that monetary policy seeks for the present, in real terms. How can any stepped up growth pattern (which might avoid overlap in unemployment numbers and the next recession) take place in an environment which does not even know yet why, or how, to address the more gradual growth pattern deemed logical? Implicit in any potential “shift” means recognizing the shift itself and how it came about – i.e. through the filling of a large set of customer preference perimeters that also defined the most recent prolonged expansion (Avent’s graphs in that regard are quite fascinating).

    Because of differences in income we have different “plateaus” of perimeter potential, but the possibilities for lower income have not yet been explored and so remain a source of potential growth for capital and jobs. The natural employment rate – which you suggest being dependent on expectations – remains caught in the expectations of the higher income consumer group, who did such a good job of filling the previously defined perimeters of the most recent expansion.


  12. 12 Luis January 11, 2013 at 4:11 pm

    David, very nice post. But I Would like to comment that I Don’t understand Why in general you don’t mention The spread between prívate and public rate. Friedman gave much relevance to it. And I think that The spread of BAA corporate bonds and Treasury Bonds have a lot to say about expectations.
    If you see
    Corporate bond rates are not so low as Tresusy rates, and The current spread is much higher than in normal times. I would think on that as a sign that confirm your word:

    Despite low real interest rates, consumers are not rushing to borrow money at low rates to increase present consumption, nor are businesses rushing to take advantage of low real interest rates to undertake shiny new investment projects.

    The spread of The graph represent the higher fear than in normal times of the savers to riskier investment. Perhaps the back to normal times is not so


  13. 13 Joshua Wojnilower January 11, 2013 at 5:24 pm

    It’s fascinating to note the combination of a Keynesian-demand side story in and Austrian/Lachmann subjective expectations view. While I agree that both aspects play a significant role in understanding current low real interest rates, there is a third uniting topic that I think is left out. The third topic is private debt and debt servicing costs, which may dampen demand for loans and simultaneously reduce expectations of future income. Unless the third topic is recognized as part of the problem, I fear remedying the other two issues will prove temporary, at best (http://bubblesandbusts.blogspot.com/2013/01/bubbling-up11013.html).


  14. 14 Diego Espinosa January 12, 2013 at 11:20 am

    The ML/BofA option-adjusted HY spread index implies a more normal (albeit elevated) risk premium. This is in keeping with HY bond issuance, which is now booming and is normally depressed when the risk premium is at abnormally high levels. Moreover, one OAS investment grade spread index shows we were at the same level in March of 2000 — hardly a time of abnormally high pessimism.



    Also, I believe spreads for financials are pulling the average spread higher, as are the number of convenant-lite HY bonds being issued. The financials spreads point to a structural banking system problem rather than a generalized level of excessive pessimism.

    Even an abnormally high spread to Treasuries is not necessarily indicative of “excessive pessimism”. If the Fed depressed 10yr yields below market levels, then the implied market spread would be lower than the observed one.


  15. 15 David Glasner January 12, 2013 at 6:40 pm

    Roman P., Thanks. My (uneducated) impression is that explaining the real interest rate is a huge gap in Post-Keynesian theory, because Keynes liquidity preference theory foreclosed any inquiry into the real factors that determine the real rate of interest. But having made that claim, I now expect my Post-Keynesian readers to come back at me and set me straight. Your citation of Cottrell (whose papers always impress me for their scholarship and incisive reasoning) seems to support my charge that there is no Post-Keynesian theory of the real rate of interest.

    anon, I agree that there would be some tendency for market agents to adjust. The point is that there is no market mechanism that eliminates the inconsistency in the way that price differences for identical products are eliminated by arbitrage. At any rate, I think that I conceded too much in my earlier response to Diego. See my further response below.

    Diego, I think it is highly problematic to assume that the Fed can be holding down long-term real interest rates simply by buying long-term Treasuries. There are all sorts of long-lived assets that people could be holding. If the Fed is holding down long-term interest rates on Treasuries, how do we explain all the other asset prices (safe sovereign debt issued by other countries), private debt and physical assets. Is there a disconnect between the prices of Treasuries and all those other long term assets that people could be holding? If not, how is the Fed’s purchases of a tiny fraction of the total existing stock of all those assets determining the yield on all those assets? I also wonder why, with real interest rates at historic lows, P/E ratios are not at historic highs? If they aren’t at historic highs, that suggests to me that the markets are pessimistic about the future, anticipating very little future growth in earnings.

    Becky, Generally growth occurs without people knowing ahead of time, precisely how and where the growth will occur. It is a fallacy of central planners that they can map out in advance which sectors will be advancing. The experts generally don’t correctly anticipate where the growth is going to come from. Those expectations are not self-fulfilling. But if people don’t think that growth is going to occur at all, that could be self-fulfilling. And so could the expectation that there will be growth even though no one really knows exactly where the growth is coming from.

    Luis, You are certainly right that the spread between “safe” government assets and “risky” private assets is very relevant. Thanks for the link, which I think does indeed show that the spread between the yield on safe and risky assets has been persistently high, and adds something to our understanding of why the “recovery” since 2009 has been so weak.

    Woj, I would appreciate it if you would elaborate on this point.

    Diego, Am I right in thinking that believe that the market for safe long-term sovereign debt is a separate market (in the sense that the purchasers of this debt tend to be very different from purchasers of other long-term assets) so that yield on long-term Treasuries is not well correlated with yields on other long-term assets?


  16. 16 Diego Espinosa January 13, 2013 at 11:15 am

    You ask a good question on QE’s effect on other markets. All credit instruments carry duration and credit risk. The Fed’s actions directly influence duration risk. Both QE and forward rate guidance encourage duration bets by lowering the expected volatility of term Treasury yields. Therefore, the duration risk component of junk yields would likewise be depressed.

    The next question is how the Fed impacts the credit risk premium. The “excessive pessimism” thesis is that wide HY spreads are a sign the Fed is not doing enough to change expectations. I have two problems with this: 1) spreads are not that wide historically; and 2) relative to the extreme pessimism embedded in negative 10yr TIPS yields, HY spreads are actually quite low. There is a “pessimism” arbitrage opportunity: if the future state of the world is “that bad”, then one should short HY spreads as they are bound to widen. Same with equities: a prediction of negative 10yr yields implies a persistent output gap and a dearth of attractive investment projects. Given such a bleak future, one would expect the S&P 500 to have an abnormally low P/E. If the bond market reflects market prices, then the S&P500 is clearly a “short”. (BTW, negative real rates correlate well with single-digit P/E’s).

    The alternative explanation is that bond yields do not reflect market prices. This is not a result of the Fed owning 15% of Treasuries, but of market expectations about the Fed’s future actions (permanence of near-ZIRP, QE, etc). For one thing, maybe markets sense that raising the IOR to, say, 4%, would cause enormous losses on the Fed’s balance sheet, and that the Fed would understandably be reluctant to self-inflict such pain.


  17. 17 Frank Restly January 13, 2013 at 4:39 pm


    Vice Versa –

    Consumption in excess of production or production in excess of consumption.


  18. 18 Mike Sax January 13, 2013 at 4:53 pm

    Low interest rates have actually been around for 30 years-you can trace a steady drop beginning in 1981-after a roughly 40 year period of ever rising rates.

    So it would be intersting for someone to analyse them over an 70 year period-what caused the 40 year bull market in rates followed by what is now about 31 years an counting in every lower rates.

    Maybe they wont drop for ever but they sure can drop for a very long time this suggests.


  19. 19 Greg Ransom January 14, 2013 at 9:27 am

    You are ignoring the role of extending and shortening of the time of production in the making of interest rates on credit.

    We’ve been in a half-decade period when the length of the time structure of production has been contracting.

    That is going to have a role in shaping the rate of interest on credit.


  20. 20 Greg Ransom January 14, 2013 at 9:29 am

    The US has massive tax increases on income and investment baked in the cake.

    That has got to have some influence on ‘expectations’ and investment-and-consumer-later vs consume now decisions.


  21. 21 Joshua Wojnilower January 14, 2013 at 8:07 pm

    “The third topic is private debt and debt servicing costs, which may dampen demand for loans and simultaneously reduce expectations of future income.”

    I’ve been reading Michael Hudson’s, The Bubble and Beyond, so my description will be guided a bit by his work. Most debt today is created by private banks not for investment in tangible capital, but in already existing assets such as land, stocks and bonds. interest payments (debt servicing costs) increase with the rise in outstanding private debt. These payments are largely a transfer from debtors (households and non-financial corporations) to creditors (banks). From the debtors perspective, the rising debt servicing costs represent “income that otherwise would be spent on goods and services.” When the rise in debt servicing costs exceeds growth in income and capital gains, the share of income set aside for debt servicing costs dampens consumer demand for goods and services (business expectations of income), as well as new credit (demand for loans).


  22. 22 Benjamin Cole January 14, 2013 at 8:49 pm

    I think the real question is, “Can the Fed get us out of zero bound, and target 2.5 percent inflation?’

    What if the answer is “no”?

    Or, what if it takes a incredible amount of money printing–QE in the trillions–to break us out of zero bound-perma-recession?

    Would the Fed have the institutional flexibility to do that?

    I don’t think so.


  23. 23 Frank Restly January 15, 2013 at 10:39 am


    “These payments are largely a transfer from debtors (households and non-financial corporations) to creditors (banks).”

    If you look at the federal reserve flow of funds reports (Z1 reports), you will discover that most debt is not held by banks.

    Click to access z1.pdf

    Page 77 – Private Depository Institutions
    Holdings – Credit Market Instruments – $11.29 Trillion
    Page 76 – Monetary Authority
    Holdings – Credit Market Instruments – $2.57 Trillion

    This is out of a total of about $55 Trillion (about 25%). The rest is held by pensions, mutual funds, life insurance companies, the federal government, foreign countries, private companies, and households.


  24. 24 David Glasner January 17, 2013 at 6:25 pm

    Diego, My claim is that the valuation of long-term Treasuries depends on expectations of yields on other assets. You say that the Fed is raising the value of Treasuries by reducing duration risk, but I say that the value of Treasuries has more to do with expectations about future profits. I think that expectations, though slowly recovering, are still forecasting slow growth in profits. You say that historically negative real rates correlate with single-digit P/E’s, but weren’t previous periods with negative real rates periods of high inflation?

    You said:

    “The alternative explanation is that bond yields do not reflect market prices. This is not a result of the Fed owning 15% of Treasuries, but of market expectations about the Fed’s future actions (permanence of near-ZIRP, QE, etc). For one thing, maybe markets sense that raising the IOR to, say, 4%, would cause enormous losses on the Fed’s balance sheet, and that the Fed would understandably be reluctant to self-inflict such pain.”

    My problem with that is that the expectations of permanence of near-ZIRP and QE would make no sense if profit expectations were optimistic. Optimistic profit expectations and near zero interest rates ought to be a recipe for an investment boom.

    Frank, My guess is that there are very, very few examples of entire economies in which consumption exceeds production.

    Mike, Nominal interest rates were rising for 40 years, but in the 1970s when inflation rose sharply, real interest rates fell. In the early 1980s the Fed drove up real interest rates to very high levels in order to break inflation expectations. But it is difficult to calculate real interest rates before there were TIPS that provided an approximate market estimate of inflation expectations.

    Greg, Whatever is happening to the time duration of production, which is an interesting phenomenon, doesn’t account for the general reduction in real interest rates over almost every time horizon.

    Joshua, Thanks.

    Benjamin, You may well be right.


  25. 25 JP Koning January 22, 2013 at 8:08 am

    “You are tacitly assuming that the zero point is perfect illiquidity, and everything short of that receives a premium. But maybe the zero point is average liquidity and anything better than that receives a premium and anything worse bears a discount. Just a thought.”

    Yes, you raise a good point. I’m not sure where to start from… average or zero. Why not perfect liquidity, for that matter.

    But there is some danger in pulling an economy-wide real rate from any one of the infinite number of assets we see trading around us, insofar as it is difficult to adjust for that asset’s liquidity premium relative to that of our theoretical benchmark. The rates on TIPS and treasuries could be falling not because the unobservable benchmark real rate is falling, but because TIPS/treasury liquidity has increased. TIPS/treasuries therefore don’t need to provide a high pecuniary return since the non-pecuniary liquidity yield compensates.


  26. 26 Frank Restly January 30, 2013 at 9:56 pm


    “Frank, My guess is that there are very, very few examples of entire economies in which consumption exceeds production.”

    If you treat the entire world as one economy then it is impossible for consumption to exceed production. You can’t consume what doesn’t exist.


  27. 27 D. Faltin June 25, 2014 at 6:15 am

    “First, it can’t be emphasized too strongly that low real interest rates are not caused by Fed “intervention” in the market. ”

    This is not really correct in my view. Empirical research by the IMF (see WEO April 2014) shows that monetary policy shocks affected, or better determined the real rate in the 1980s and unconventional monetary policy pushed down real rates since 2008.
    Another, more interesting theory was advanced by the BIS (Bank of International Settlement), which states that flawed monetary policy has contributed significantly to the secular downtrend in global real interest rates by creating a disequilibrium between effective real rates and the unobservable naturual equilibrium real rate. This disequilibrium has weakened the productive forces (production strucutre) of the economies and thus reduced the growth potential and the real rates of interest. This theory relies on the capital-based business cycle theory advanced by F.A. Hayek.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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