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.