阅读|The causes and challenges of low interest rates
The causes and challenges of low interest rates: insights from basic principles and recent literature
低利率的原因和挑战：基于基本原理和最新文献的见解
Youchang Wu
Department of Finance, Lundquist College of Business, University of Oregon, Eugene, Oregon, USA
Citation:
Wu, Y. (2020), "The causes and challenges of low interest rates: insights from basic principles and recent literature", China Finance Review International, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/CFRI-06-2020-00
关键词
Interest rate, Safe asset, Tail risk, Secular stagnation, Monetary policy, Zero lower bound
摘要
Purpose
What causes the downward trend of real interest rates in major developed economies since the 1980s? What are the challenges of the near-zero interest and inflation rates for monetary policy? What can the policymakers learn from the latest developments in the monetary and interest rate theory? This paper aims to answer these questions by reviewing both basic principles of interest rate determination and recent academic
and policy debates.
Design/methodology/approach
The paper critically reviews the explanations for the downward trend of real interest rates in recent decades and monetary policy options in a near-zero interest rate environment.
Findings
The decline of real interest rates is likely an outcome of multiple technological, social and economic factors including diminished productivity growth, changing demographics, elevated tail-risk concerns, timevarying convenience yields of safe assets, increased global demand for safe assets, rising wealth and income inequality, falling relative price of capital, accommodative monetary policies, and changes in industry structure that alter the investment and saving behaviors of the corporate sector. The near-zero interest rate limits the space of central banks’ response to economic crises. It also challenges some conventional wisdoms of monetary theory and sparks radically new ideas about monetary policy.
Originality/value
This survey differs from the existing work by taking a broader view of both economics and finance literature. It critically assesses the economic forces driving the global decline of real interest rates through the lens of basic principles and empirical evidence and discusses the merits and limitations of each proposed explanation. The study emphasizes the importance of a better understanding of economic forces driving diverging trends of corporate investment and saving behaviors. It also discusses the implications of the neo-Fisherism and the fiscal theory of price level for monetary policy in a low interest rate environment.
文章结构
Introduction
The determination of real risk-free rates: basic principles
2.1 Risk-free rates in the consumption-based asset pricing theory
2.2 Real risk-free rates in a production economy
Reasons for the decline of the real interest rate
3.1 Factors highlighted by canonical models
3.2 Factors beyond canonical models
Challenges for monetary policy
4.1 The monetary policy conundrum at the zero bound
4.2 Neo-Fisherism
4.3 The fiscal theory of price level
Conclusion
研究成果
Interest rates trends
Total factor productivity growth rate
Tail risk and real interest rate
Corporate investment, saving and cash holdings
主要结论
There is a significant decline in real interest rates, defined as nominal rates minus expected inflation rates, in major developed economies since the 1980s.
The neoclassical asset pricing theory and growth theory provide a useful framework for understanding the downward trend of real interest rates. The canonical models suggest that the risk-free interest rate is determined by the subjective discount factor, the expected consumption/productivity growth, the riskiness of the consumption/productivity growth, and the population growth. It also suggests that a negative real interest rate can arise naturally when the expected growth rate is low and when the risk is large. These predictions are helpful for understanding the downward trend.
The decline coincides with a slowdown of productivity growth since the 1970s. However, recent studies only find a tenuous long-run correlation between the real risk-free rate and productivity growth. In addition, the real return on productive assets has been stable in recent decades. These findings suggest that slow productivity growth may not be the reason for the secular decline of the real interest rate. The negative effects of some demographic trends, including lower population growth, lower fertility rate, increased longevity, have received stronger empirical support. Nevertheless, the quantitative importance of these demographic trends needs to be assessed with caution, given that these trends coincide with a sharp decline in the personal saving rate and a diminished share of households’ contribution to the aggregate saving of the economy. Elevated tail-risk concerns, together with large convenience yields of government bonds during extreme events, provide a credible explanation for the decline of real interest rate after the 2008 financial crisis. Since agents do not know the true shock distribution, extreme events such as the 2008 crisis and the 2020 pandemic can have a long-lasting effect on the perceived tail-event probability. Tail-risk concerns may also have contributed to the increased demand for safe assets of developed countries after the financial crises in emerging markets in the 1990s.
Factors beyond the standard theory also help to explain the interest rate decline. These include the increased global demand for safe assets of developed countries, the accommodative monetary policy, the falling relative price of capital, and the rising wealth/income inequality. The convenience yields of safe assets provide an explanation for negative nominal risk-free rates in Japan and Europe. Given the large increase in corporate saving relative to corporate investment in recent decades, a better understanding of economic forces driving the diverging trends of corporate investment and saving behaviors should be very helpful for understanding the trend of the real interest rate.
A critical review of each explanation put forward in the literature suggests that each explanation has itsmerits, but none of them provides a full qualitative and quantitative account of the real interest rate dynamics in recent decades. It is plausible that the secular decline of the interest rate is a joint outcome of most if not all the factors mentioned above. Furthermore, since most of these factors represent relatively slow evolution of the real economy without a clear sign of reversal in the near future, the low real risk-free rate is likely to persist for some considerable time.
The low interest rate poses a conundrum for monetary policy as it limits the space for rate cuts in response to potential crises. Even if a negative nominal rate is theoretically justifiable and technically feasible, it is not necessarily stimulating. Due to its negative impact on banks’ net worth, a low interest rate can reverse to become contractionary. Importantly, this reversal rate is not necessarily negative.
The low interest rate and low inflation economy also push economists to rethink the fundamental principles of monetary theory. The neo-Fisherist view of the monetary policy argues that the conventional Taylor rule–based policy has a tendency of falling into the liquidity trap. A radical policy recommendation coming out of this theory is that in order to break the liquidity trap central banks should increase instead of decreasing the nominal interest rate. If the prevailing interest rate is below the reversal rate, then a rate increase can indeed be stimulating. Unconventional monetary policies like this should be evaluated with caution as there may be unintended consequences.
According to the fiscal theory of price level, the general price level is determined by the demand and supply of government debt instead of money supply. Quantitative easing itself has little inflationary effect because government debt and bank reserves are almost perfect substitutes for banks. Furthermore, it is possible to have a stable economy with a low interest rate without a Taylor rule-type intervention policy. Given that the majority of money in today’s economy is used for financial transactions instead of buying goods and services, an alternative theory of price level based on the supply and demand of government debt offers a valuable new perspective. However, it is important to recognize the negative effects of low interest rates on institutions and populations relying on stable cash flows of fixed-income assets. Also, the valuation of the aggregate government debt portfolio is still a challenge for the asset pricing theory. The subjectivity of government debt discount rate implies that it could increase abruptly when investors become concerned about the government’s ability to pay off its debt, in which case the resulting runaway from government debt in exchange for goods and services will jeopardize price stability. The fiscal theory of price level builds on the idea that price level is anchored by fiscal policy; a natural conclusion that should follow is that price stability must be built on fiscal discipline.
作者简介
Youchang Wu (吴有昌), Associate Professor of Finance | John B. Rogers Research Scholar | Coordinator, Finance PhD Program at Lundquist College of Business, University of Oregon.
See more information at:
https://business.uoregon.edu/faculty/youchang-wu
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