Maybe Low Interest Rates Won’t Last Forever
(Bloomberg Opinion) - Conventional wisdom and financial markets agree: the era of near-zero interest rates will last as far as the eye can see. According to a provocative new book by Charles Goodhart of the London School of Economics and Manoj Pradhan of Talking Heads Macro, the long era of low interest rates may indeed be coming to an end.
Over the past decade in particular, inflation-adjusted interest rates have remained remarkably low. The 10-year rate of return on constant-maturity inflation-linked Treasury bills in the US fell below 1% in 2011 and hovered near zero until the pandemic. The return in the third quarter of 2020 averaged -0.9%.
Almost no one predicts a sharp rebound in nominal or real interest rates. The Congressional Budget Office assumes that the 10-year nominal return will not return to 2010 levels until 2030. The markets are also signaling that they do not expect the era of low interest rates to end anytime soon: The 30-year inflation-adjusted rate of return The weighted average of interest rates expected over three decades is likely to have remained negative since the outbreak of the pandemic.
So what could go wrong? First, and to get this out of the way, I was wrong more than a decade ago about worrying about rate hikes. History, to say the least, was not kind to that view. By 2011, I'd seen enough to know that my initial fears were misplaced, and the lesson I learned the hard way is to be more skeptical of conventional wisdom. (1)
The prevailing view, however, has moved very far in the opposite direction from 10 years ago, from excessive concern to no higher rates in the future. Now comes "The Great Demographic Reversal: Aging Societies, Decreasing Inequality, and a Revival of Inflation" by Goodhart and Pradhan to refute the new conventional wisdom.
The authors argue that the era of low interest rates was largely caused by demographics and the entry of China and Eastern Europe into the global trading system. The result was that effective global labor supply more than doubled between 1991 and 2018, which in turn pushed interest rates down (while depressing inflation and wages, and increasing inequality). You write, “The rise of China, globalization and the reintegration of Eastern Europe into the world trading system, along with ... the arrival of the baby boomers in the labor force and the improvement in dependency, along with higher employment of women, has produced the greatest massive positive shock to the labor supply triggered all the time. “The deflationary pressures created by this offer led to an era of low nominal and real interest rates.
Goodhart and Pradhan further argue that the demographic sweet spot of the past three decades is now reversing and the dependent (elderly and young) to worker ratio is increasing in the advanced economies and in China. Indeed, the working-age population is stagnating or falling in most of the world outside of Africa and India.
The underlying tectonic plate of aging, the authors argue, will soon reverse previous deflationary pressures. The consequences? "The main thesis of this book," the authors write, "is that the great demographic reversal will shortly increase inflation and interest rates."
You address the various counter-arguments but find them unconvincing - for example, that Japan is already aging quickly and has not seen interest rates rise. In the case of Japan, they find that a country that is aging rapidly when it can draw on workers in other countries is very different from the world as a whole. They are skeptical that Africa and India will be able to exert the same deflationary pressure in the future as China in the past.
The book's conviction may be exaggerated, but we should thank Goodhart and Pradhan for kicking the tires as the low rates will stay here as conventional wisdom can easily blind us to other scenarios. As they say: “Once established, conventional thinking is extremely difficult to displace, especially at turning points. We are at such a turning point right now. “The first part is undoubtedly correct, even if the second part turns out to be premature.
(1) In a similar context, and as this story is now being re-litigated, the simple narrative that caught on through the 2009 incentive seems out of place. As I wrote in 2019, the problem with the 2009 stimulus wasn't that it was too small, but that it didn't last long enough. It is not clear that much more could have been effectively delivered in the second quarter of 2010 than the well over $ 100 billion contained in the stimuli for that period. It is clear, however, that the federal government could have spent more than $ 10 billion in the second quarter of 2012.
This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.
Peter R. Orszag is a columnist for the Bloomberg Opinion. He is the chief executive officer of financial advisory at Lazard. From 2009 to 2010 he was Director of the Office of Management and Budget and from 2007 to 2008 Director of the Congressional Budget Office.
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