Why are short-term real interest rates so persistently negative these days?

Low productivity will get rates low but not consistently negative.  Why might they be negative is a question raised by Brad DeLong and also Paul Krugman, in response to my earlier post about the natural rate of interest.

The most obvious answer is “risk,” but unfortunately that is directly contrary to the data.  The domestic and global economies have become much less risky since 2008-2009, and yet if anything negative real rates for safe short term assets seem all the more ensconced.

VIX volatility indicators are down (admittedly there is a spike back up since August, but that is not going to do the trick, try the ten-year series too), consumer confidence is back up, and so are business confidence indicators.  The TED spread, Krugman’s own previously favored index of extreme volatility, has been way down for years.  The eurozone crisis of 2011 has passed, at least for the time being.  Some of the emerging economies aside, most market prices are signaling low risk.  So it is strange to invoke high risk to explain current asset prices, when the relevant prices and yields do not seem to be moving with that risk.  If it is indeed risk, it is risk of a kind which we do not know how to measure or perhaps even conceptualize.

The other hypotheses are interesting but unproven, let’s take a look:

1. The Fed.  There is a well-known liquidity effect on short-term real rates, but it is usually pretty small.  Plus German real rates were negative well before the ECB started its QE.  If there is something here, it remains to be shown.

2. Growing corporate demands to hold cash.  This is a secular long-run trend, and most corporations wish to hold safe assets for agency reasons, and that will depress rates of return on those assets.  Maybe there is something here, but again the connection remains to be shown.  But do read Richard Koo from 2004 (pdf) and also see Ed Conard’s book, which discusses why cross-border investment tends to “go safe.”

3. Growing legal and institutional requirements for T-Bills as collateral.  I have played around with this hypothesis, but still its relevance remains to be demonstrated empirically.  Furthermore commercial paper rates may be too low, and that gap too small, for this to be a major factor.

4. CPI mismeasurement.  Maybe the world is seeing more deflation than we are measuring, and short rates aren’t negative at all, as Arnold Kling has suggested.  I’m not myself convinced, but this list is a survey, not a summary of my opinion.

5. Other???

Given those options, it seems to me highly premature to assume we know what is going on with short-term negative real rates.  And it is all the more premature to imagine that a “more negative” set of rates is a solution to our remaining macro problems.  I also am not sure which of the above factors should count as “natural” or “artificial” determinants of rates, so again I find it wiser to not build in those concepts as part of one’s opening terminological gambits.  Most generally, if someone is telling you that the answer to a question about real interest rates is “simple,” they are likely wrong.  Especially these days.

Addendum: You’ll find various perspectives on negative real rates here.

Second addendum: This is not my main point for today, but I consider all of the above further reason for monetary policy to focus on ngdp rather than interest rates.


If we had to guess, a combination of #3 and #4. For #3, the U.S. Federal Reserve implemented new regulations in September 2014 specifically requiring large and internationally active banking institutions to load up on "high quality, liquid assets" (a.k.a. U.S. Treasury securities).

For #4, using a some rather unique economic indicators, we would suggest that China effectively began exporting deflation after its Third Plenum in October 2013, in which it acted to reset the growth trajectory of the nation's economy to a lower level.

Of the two, the impact of #4 is much larger than #3. Empirical data however indicates that both factors are significant contributors to the developing phenomenon of negative real rates in the U.S.

Any serious explanation should address the global decline in nominal rates since 1982.

One hypothesis is that "Financial Repression" from WWII (Bretton Woods) to the first repeal of Regulation Q (in 1980 in the USA, and in toto in 2011 says Wikipedia). So the thesis is that in a Neo-Fischer sense, governments worldwide regulated capital and this kept rates *high* for decades, since the money was "tied up in the domestic home country market" and could not escape to the US/UK. Once capital was allowed to migrate, it left for the USA/UK, which lowered the cost of capital in the USA/UK, and ultimately the world via US exports of capital from multinationals doing business abroad. As a counterexample of this, in China, where financial repression is still practiced, you should see higher nominal rates than in the USA.

Just a thesis, I'm not sold on this but it falls under "OTHER".

Trends in central banking?

Really what amazes me about that 160 year chart is the degree to which it is not random or chaotic. It has noise, but is predominantly about these big long features, like the valley from 1922 to 1982.

That is a 60 year feature, affecting the global economy.

The huge spike in 1981 when Volcker decided to crush inflation makes other fluctuations look small but they were not.

He perhaps planted the flag on the mountain top, but the run-up began in 1954. Again huge long trends.

Housing starts have been at depression levels for nearly a decade, mortgage credit markets are dead, and all of the related dislocations mean real estate yields are well above bond yields. All of this means there is something like $25 trillion in missing real estate relative to what long term trends would have suggested we should expect. Those are a lot of missing vehicles for savings.


#5 Low ratio of good investment projects that need short money to people offering short money. Which I think is what Krugman basically wrote.

Re #1: I think the central bank has power over real rates but not of the kind many want. It definitely could tighten and raise both nominal and real rates. The supply of short safe assets (M2ish + Tbills) is also determined by Treasury and commercial banks.

A thought on #5: low demand for credit: consumer delevering?

Also, On FOXBusiness, Art Laffer said at 3.5% lenders are reluctant to supply 30-year, fixed-rate residential RE credit (I have a 3.875% 30 year fixed rate mortgage loan and a 2.69% five-year auto loan) impairing RE construction and market activity. I don't fully agree. See FNMA/FHLMC.

Households borrow long.

#6: The option value of short-term bonds for intermediate-term currency speculation. Note that in Europe the most negative rates are associated with non-Euro continental currencies where a de-facto peg to the Euro probably cannot be maintained.

Also, there continues to be speculation that the Euro itself will not survive. There is option value in holding holding short-term German bonds versus, say, short-term Italian bonds. If Germany left the Euro the "new" Deutschmark would immediately appreciate. Negative rates are a kind of option premium.

"The domestic and global economies have become much less risky since 2008-2009"

Do not confuse long term risk with short term volatility. There are huge risks in the bond markets in the duration risk associated with long bonds at low interest rates. A rational portfolio that holds long bonds might well hold some short term bonds at negative rates.

(There is also the small matter that inflation is poorly defined and difficult to measure so real rates might not be negative.)

"Why are short-term real interest rates so persistently negative these days? " - simple, because central banks have clearly indicated by all their actions and rhetoric that now the 2 to 2.5% inflation target is a ceiling not an average. Especially compared with what it was in the 1990's and 2000's (average was about 2.5%). So money can be expected to broadly not lose value in the short term. So that means you should not expect to make a lot of money lending to someone in the short term. In fact, if you have to put some large amounts of money away for a short time period, be prepared to pay a storage fee, like you would for gold. Essentially we are back to the gold standard, in fact even better because gold is not a good hedge against general price rises in the short term (gold could fall in value due to new discoveries for instance), whereas the CB can adjust money supply to keep the value of money constant.


I like this answer, but think rather than picking 2% inflation CBs were forced to accept it for a variety of reasons political, technological, demographic, ...

How can the first reason not be "demographics"?

Demographics still has to "work through" some other set of variables, and also note that American TFR has been running pretty close to 2.0 and our population is not shrinking. Simply having more old people may lower productivity of course, but productivity is the first factor listed.

The savings glut, to the extent that it is real, is supposed to come from global millions (billions?) entering prime working/saving years.

In the case of China is was millions of new workers and savers just dumped into a global economy.

"The savings glut,"

Comes in part from sovereign wealth funds and tax avoidance. The savings glut is not just Chinese savers exporting capital from China.

I am not a good enough mathematician to express this eloquently, but for a while now the professionals have been factoring in interest rates as set by the Fed (not markets) in their understanding of how the economy works. This has lead to abuse of the Fed as the economy has depended more and more on lower and lower interest rates to juice the economy. The Fed is not able to raise them for fear of causing too much damage to the world economy.
This has continued until the Fed has no lower to go. Now as pressure continues to push the rates lower still, the well shows it is dry. Until professionals adjust their expectations this will continue to push. Given past examples, there will likely be a crisis the Fed cannot meet and in hindsight this will all be obvious and we will shake our heads at how foolish our past selves were.

"2. Growing corporate demands to hold cash. This is a secular long-run trend, and most corporations wish to hold safe assets for agency reasons, and that will depress rates of return on those assets. Maybe there is something here, but again the connection remains to be shown. But do read Richard Koo from 2004 (pdf)..."

I did several posts debunking Koo a couple of years ago, and like most memes pushed by Koo this one evaporates under closer scrutiny.


Who to believe, Koo, or Koo-Koo?

Could it not be attitufes towards, rather than just perceptions of, risk? Perhaps risk aversion has increased, particulalry in the ckntext of firms' capex in real assets where the consequences of failure are worn by managers.

The "very-sharp Tyler Cowen" (DeLong's description) is employing what might be called the "reasonable doubt" approach to debating an economic issue (in this case the "natural" rate of interest): posit a whole bunch of plausible explanations to raise a reasonable doubt about any particular one (especially the one he doesn't like). This is not a criticism of Cowen, but an acknowledgment that the adversarial method is now an accepted practice by some in economics. I suspect that's what DeLong means by the "very-sharp Tyler Cowen"; it was DeLong who, agreeing with Paul Romer, expressed annoyance with the practice.

"...posit a whole bunch of plausible explanations to raise a reasonable doubt about any particular one (especially the one he doesn’t like). This is not a criticism of Cowen, but an acknowledgment that the adversarial method is now an accepted practice by some in economics. ..."

Perhaps you'd like to make an actual argument? Because your post come across as snarky/whiny and not very informative.

#3. Bank balance sheets are a lot different than they were 10 years. Three letters. L-C-R.

That there is a natural rate of anything, including interest rates, sounds a little old fashioned, a thought likely to be had by a cleric rather than an economist.

What is the natural birth rate? The natural rate of unemployment? The natural interest rate?

What is the natural yogurt.

Ok, I guess I know what is the natural yogurt.

Is the natural rate of interest related to the iron law?

"Ok, I guess I know what is the natural yogurt."
Do you really?

@Ted Craig- the whole Med Diet thing is a fraud IMO. In the final analysis, there are people in Japan and Greece and Siberia and all over the world that live long lives due to genetics. I have some in my family and they ate fatty foods, some of them smoked, and they lived until their 90s and a couple to 100. A few of them died of bacterial diseases easily treatable but they refused to visit a doctor since they never went to doctors all their lives. Genes not greens.

For a random sample you're probably more likely to die going to a hospital than be saved. Go in for the flu, go out in a gurney after you catch drug-resistant MRSA

Plus you can get fish antibiotics without having to see a doctor.

Why are interest rates so low?

1) Demographics - The Developed World Baby Bust is having more impact on the need for investment.
2) The crisis was a melting up...Wages have stagnated for 15 years and is melting up to interest rates.
3) IT investment has more deflation - We spend less on IT but aren't we getting more?
4) China Productivity - The most 'expensive' investment is factory building and that is all in more nation.

I think I agree with these as global factors commonly affecting mature market democracies. A global system that shakes out similarly in the US, Canada, Germany, Sweden

Are factories the most "expensive" investment?

Maybe some.

In China they are mainly hastily thrown up brick/concrete shells with some machines in them.

The machines sometimes aren't even very expensive, especially as they are/were relying on cheap labor.

That said, there are factories stuffed with expensive machines, too. Those probably are some of the most expensive investments, but there may be non-manufacturing investments that rival those. Maybe deep-sea oil rigs.

In reality mining equipment is the most expensive investment and it had mini-bubble from 2012 - 2014. (Mini-bubble is simply a micro over-investment.) Unfortunately, maybe modern Chinese factories with less investment are much like IT deflation...Which the global economy has learned to spend less on investment but receiving more benefit from it.

Well, we've kind of broken the risk mechanisms, haven't we? Before the era of "too big to fail" and targeted bail-outs, you had to pay a risk premium to invest in sketchy-but-high-potential markets. Where is the risk premium now?

Does anyone believe that the US Congress, Treasury and Justice Department would pay 5.6% on the debt? I don't. That is why the rates are low, enough to keep the debt financing costs low enough to stay out of the news.

What happened when a Euro country started having to pay rates that represented their risk? Private lending was wiped out leaving a smaller debt to other sovereigns and their national banks at a lower rate. We wouldn't want sovereign risk to actually be costed would we.

It could be we are just having a different form of inflation - rich people's inflation.
If the amounts of money in the hands of exteremly rich persons grow, but not in the average hand, and given that from ordinary products rich people won't consume a lot more - we would see inflation only in stuff that only very rich people want.

To quate Krugman: http://krugman.blogs.nytimes.com/2015/10/31/the-hamptons-hyperinflation-endorsement/
"Check out London, Manhattan, Aspen and East Hampton real estate prices, as well as high-end art prices, to see what the leading edge of hyperinflation could look like."

That could just be demand and not inflation. All of those items are limited in number. As more rich people are created they demand goes up. That is not price inflation due to over supply of money.

As I understand it, that is a text book definition of inflation:

Increse in the money supply causes the price people are willing to pay to rise, and they can't be produced in large enough quantity at current prices, which then causes prices to rise.

This non-economist asks, with respect to #5:

could the cumulative macro effects of the world's economies' holding their collective breaths, pending outcomes on global climate negotiations that could impact broad-based industrial and regulatory commitments across the rest of this century, be a single factor significant enough to curtail enough investment that would restrain corporate spending for both production and employment?

To the extent that the people I know are dialed in, elites have decided on adaptation, rather than severe carbon restrictions.

Perhaps I should not be as skeptical as I am about carbon theatre ...

Under 5. Other??? I'm surprised TC did not list "Great Stagnation", meaning there aren't any good projects to invest in anymore, hence rates trend down.

This is a form of risk, that of the long term, where the option value of short term holding exceeds obtainable long term returns just in case something new comes along and the stagnation ends.

Why short term rates are low is an "easy question" -- a lack of economic growth for middle class folk, including very low rates of new company formation. Why so little real growth?
a) Taxes and disincentives for starting a new business.
b) Regulations and gov't caused problems for companies.

Imagine 2 laws: 1) No new companies can be formed; 2) No existing companies can hire new workers. With both of these obviously stupid laws, "growth" would become almost illegal, and no amount of monetary nor fiscal stimulus would help.
So relax both laws, so 1) regulations make it so difficult to form new companies that only a few are formed; 2) taxes financially punish companies that hire new workers, so only a few hire net new workers (total new - old that leave).

Neither low interest rates nor even NGDP targeting will be successful if parasitic taxes and regulations are stronger disincentives than other positive incentives.
Why don't economists know when taxes are too high? When regulations are too onerous?

This kind of thing, where someone looks at their local economy, pretends it is isolated, and that politics can explain it, is very common but very damaging.

We do our political economy no favors when we build a blinkered view.

How does one hedge the risk of holding a long bond (and large and important entities have to hold these long bonds) at a sub 1.5% interest rate? One of the ways is surely to hold some shorter maturities at even sub-zero rates. The black hole is open for business.

How about asking some people who are buying short-term safe assets? Not everything is a thought experiment.

You know that does seem like an obvious question? Where is the basic news reporting on this?

Fair point. Two big buyers are foreign sovereigns and big tech companies sitting on piles of cash.

People save for future consumption, but not the same consumption as day to day consumption. And people who save are different from the average spenders. Maybe the rate of inflation of stuff people (who save a lot) usually buy with their savings (real estate, cars, holiday...?) is expected to be negative in the next years.

If the "natural" rate is negative why would TIPs have a significant positive yield? 65bps for 10yr paper.

"4. CPI mismeasurement. Maybe the world is seeing more deflation than we are measuring, and short rates aren’t negative at all, as Arnold Kling has suggested. I’m not myself convinced, but this list is a survey, not a summary of my opinion."

Two things:

1) Just yesterday, I bought 6 Cree XLM-T6 Ultrafire flashlights for $18. (That's $18 total, not $18 each.) I already had two. The performance is absolutely remarkable. Even 20 years ago, I doubt you could have bought a flashlight with that power and focusing capability at any price...let alone one that also runs for many hours on a single AA(!!!) battery. If Commissioner Gordon had these babies, he wouldn't need the searchlight to send out the Bat Signal.

2) I have an Philips Norelco Aquatec rechargeable shaver. I last charged it August 28th. (!!!). It's almost unimaginable to me to have a shaver that's used every day last more than 2 months on a charge. And the heads can be rinsed in water to boot.

So I think it's very difficult for CPI calculations to keep up with such improvements in functionality/quality, in addition to tracking simple changes in price.

Inflation and deflation is, at least partly, driven by psychology. An aging population thinks the correct price for a good is far below the current price, and is therefore resistant to price increases.

(and all other aspects of an aging population, including more risk averse etc)

It ties in with (2) which is the shortage of good investment opportunities.

There is a finite pool of investments that have a comfortably sure prospect of an above zero rate of return, and each of the investments in that pool has a finite dollar amount. The sociology of the market is such that investing in something really risky that could produce high returns is out of fashion. Once people run out of good investments (and the realized preference of so many tech giants to hold cash rather than invest suggests that it this class of investments might be fully subscribed), all that is left is T-bills.

Rates (various) as indicators of risk(s).

What risks, specifically? Risks in what "mix?"

How do "rates" (which ones) indicate risks of deflation?
Slowness of reflation?

Inflation (everybody knows that - the next Geico ad).

War? Commodity "shortages?" Fiscal policies?

Russian demographics?`

"This is a secular long-run trend, and most corporations wish to hold safe assets for AGENCY reasons"

I have to admit, I'm not getting that one. What does TC mean by "agency reasons"?

A lot of good ideas, but I'll add another point. Modern investors view treasuries as much more a safe-haven than their predecessors. You can attribute this to widespread popularization of indexing and the CAPM. The typical investor in 1980 was more likely to view his stock-holding in IBM, GM or Boeing as an investment in that specific company. Today investors realize that regardless of what specific equities they're invested in, they still have exposure to a generalized market beta. Those with pessimistic views of yesteryear were more likely to shift their holdings to "defensive stocks", whereas nowadays they're more likely to move sell all risk assets and move to treasuries. This is evidenced by the fact that treasuries and equities return series have much more negative correlations in the past decade than they ever had before.

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