Paul Schmelzing — Global real interest rates since 1311: Renaissance roots and rapid reversals

I take long-term historical studies like this is a large grain of salt, for lack of homogeneity and the difficulty in obtaining reliable data, for example, but it is interesting to look at anyway with caveats.

What is probably most interesting about it now is that the Bank of England is apparently looking at this.

Conclusion

On aggregate, then, the past 30-odd years more than hold their own in the ranks of historically significant rate depressions. But the trend fall seen over this period is a but a part of a much longer ”millennial trend”. It is thus unlikely that current dynamics can be fully rationalized in a “secular stagnation framework”. Meanwhile, looking at past cyclical patterns, the evidence suggests that when rate cycles turn, real rates can relatively swiftly accelerate.

Bank Underground
Global real interest rates since 1311: Renaissance roots and rapid reversals

Paul Schmelzing, visiting scholar at the Bank of England from Harvard University, where he concentrates on 20th century financial history

Cameron Murray — The mysterious real interest rate of economic theory

The mysterious real interest rate - the one typically denoted as r in economic theory - does not have a real life counterpart. This is a problem for economic theory. And it is a major problem for policy makers relying on monetary policy to boost economic activity.

While we think of the nominal interest rate minus inflation as getting close to the theoretical concept of real interest rates, changing this value in practice through central bank operations does not actually change the real return on capital and stimulate investment through that channel.

Why?

Because the price of capital is determined by the interest rate! We have known this for a long time. Joan Robinson wrote about the circularity of reasoning when we measure the quantity of capital by its price. She was ignored. As I expect to be.…

Fresh economic thinking

The mysterious real interest rate of economic theory
Cameron Murray

Brad DeLong — We Are so S---ed. Econ 1-Level Edition

As I told my undergraduates yesterday:

Y = μ[co + Io + NX] + μG - μIrr

where:

• Y is real GDP
• μ = 1/(1-cy) is the Keynesian multiplier
• co is consumer confidence
• cy is the marginal propensity to consume
• C = co + cyY is the consumption function--how households' spending on consumption goods and services varies with consumer confidence, with their income which is equal to real GDP Y, and with the marginal propensity to consume
• Io is businesses' and banks' "animal spirits"--their confidence in enterprise
• r is "the" long-term risky real interest rate r
• Ir is the sensitivity of business investment to r
• NX is foreigners' net demand for our exports
• And G is government purchases. Read MOAR

And as I am going to tell them next Monday, real GDP Y will be equal to potential output Y* whenever "the" interest rate r is equal to the Wicksellian neutral rate r*, which by simple algebra is:

r* = [co + Io + NX]/Ir + G/Ir - Y*/μIr

If interest rates are low and inflation is not rising it is not because monetary policy is too easy, but because r* is low--and r* can be low because:

• consumers are terrified (co low)
• investors' animal spirits are depressed (Io low)
• foreigners' demand for our exports inadequate (NX low)
• or fiscal policy too contractionary (G low)
• for the economy's productive potential Y*.

The central bank's task in the long run is to try to do what it can to stabilize psychology and so reduce fluctuations in r*. The central bank's task in the short run is to adjust the short-term safe nominal interest rate it controls i in such a way as to match the market rate of interest r to r*. For only then will Say's Law, false in theory, be true in practice….

Grasping Reality

We Are so S---ed. Econ 1-Level Edition
Brad DeLong | Professor of Economics, UCAL Berkeley

John Aziz — A Visual Representation of the Zero Bound

Azizonomics
A Visual Representation of the Zero Bound
John Aziz

The monetarists hold that this is only because negative real rates are ruled out in the existing system. If it were possible to charge for reserves instead of paying interest on them, then you would see how they are right. Sure could fool me looking that that chart.

Tim Duy — The Importance of Printing Your Own Currency

Time and time again, Japan sticks out like a sore thumb that those preaching the unsustainability of government debt want to sweep under the rug with the "Japan is a special case" story (a country fixed effect). But it seems more likely that Japan's economy is behaving exactly as you might expect given that it issues debt in its own currency. In other words, Japan is just a normal case pushed to the extreme.

Tim Duy's Fed Watch
The Importance of Printing Your Own Currency
Tim Duy

Bill McBride — Bernanke: How are long-term rates likely to evolve over coming years?

Bernanke: "...it is useful to decompose longer-term yields into three components: one reflecting expected inflation over the term of the security; another capturing the expected path of short-term real, or inflation-adjusted, interest rates; and a residual component known as the term premium. Of course, none of these three components is observed directly, but there are standard ways of estimating them....

"If, as the FOMC anticipates, the economic recovery continues at a moderate pace, with unemployment slowly declining and inflation expectations remaining near 2 percent, then long-term interest rates would be expected to rise gradually toward more normal levels over the next several years."

Calculated Risk
Bernanke: How are long-term rates likely to evolve over coming years?
Bill McBride

Ashwin — On The Folly of Inflation Targeting In A World Of Interest Bearing Money

As Mervyn King notes, inflation targeting has always been about improving the “credibility and predictability of monetary policy”.

However, in a world where money earns interest, minimising the uncertainty of macroeconomic policy does not equate to minimising the volatility of inflation. When all money bears interest, all that matters for those who hold money or bonds is the real interest rate earned on money and bonds. Given the fiscal stance and state of private credit growth, central banks should manage the real rate of interest such that rentiers do not capture a free lunch (i.e. real rates should not be too high) and there is no risk of a hot-potato/credit-bubble cycle (i.e. real rates should not be too low).

Money does not bear interest today because central banks pay interest on reserves. The primary reason why we live in a world of interest-bearing money is the gradual deregulation and innovation in financial markets over the last thirty years that triggered a shift from money to near-money assets. Apart from minimal liquidity reserves, there is simply no need to hold significant amounts of money in one’s zero-interest current account. Individuals can hold money in money market funds or treasury ETFs. Firms and high net-worth individuals can simply hold treasury bills that are as risk-free and liquid as money is. Even treasury bonds consist of a risk-free component that can be separated from the duration-risk component and monetised via the repo market. The equivalence of money and bonds is not just a temporary “liquidity trap” phenomenon. The evolution of financial markets means that the role of interest-free money is obsolete, now and forever.

In such an environment, the uncertainty and the volatility that individuals and firms care about is the volatility of the real interest rate.

Macroeconomic Resilience
On The Folly of Inflation Targeting In A World Of Interest Bearing Money
Ashwin

UPDATE:

Frances Coppola comments:

The liquidity trap as herald of fundamental change

UPDATE: Andy Blatchford notes:

Kalecki 1943

The rate of interest or income tax [might be] reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously."

Matias Vernengo — Krugman and the natural rate again

So what, now he is a Real Business Cycle (RBC) guy? Just drop the natural rate already. Evidence and logic require it.

Naked Keynesianism
Krugman and the natural rate again
Matias Vernengo | Associate Professor of Economics, University of Utah