Why are long-term nominal interest rates still low (the ten-year Treasury is about 2.7 percent)? I think that two of the standard explanations cause difficulties for the PSST view. Consider:
1. The Fed is doing it. This is problem because from a PSST perspective, the Fed should have very little effect on interest rates, particularly long rates. Yes, I know that the Fed is intervening in long-term credit markets, but it is still not a large player relative to total debt outstanding.
2. There is weak aggregate demand. This works well from an AS-AD perspective, but not from a PSST perspective.
Here are the explanations that might be consistent with PSST.
3. We are experiencing a bond bubble. A lot of irrational investors (foreign, perhaps?) are pushing bond prices higher than they ought to be.
4. Inflation is over-stated, particularly in the U.S. The prices of internationally tradable goods are falling. So the real interest rate is actually high. The rise in official inflation measures is in sectors like health care and college tuition, and there are no leveraged plays in those sectors. (If prices were rising for manufactured goods, you could borrow money to build factories and make lots of money. There is no comparable way to take advantage of rising college tuition or health care spending.)
I think I like (4) the best. What it suggests is that if you have your savings in a money market fund earning very low interest, you are actually doing well, as long as you do not face paying for college or paying for your own health care. Your personal cost of living is probably falling. What should concern you is the possibility that the government will find it necessary to adopt much more inflationary policies in order to pay its bills. If that happens, you will need some real assets in order to avoid having your savings wiped out.
You don’t think we’re experiencing a bond bubble?
What’s the defining characteristic of a bubble? Speculators stop expecting to get paid based on what the asset will actually return (whether from dot-com companies making profits, homes being rented to or purchased by non-speculators, etc) and start expecting to make a return by selling to another speculator at a higher price (the “bigger sucker” theory). It doesn’t matter if you overpaid for something as long as you can turn around and resell it to someone who will also overpay, right?
Now, how are holders of government bonds currently expecting to be paid? Are we planning (or even able) to raise taxes and cut spending so much that we can use the excess revenue to pay down our debts? Or are we planning to just issue even more debt later and get the new bond holders to repay the old bond holders?
This doesn’t look like a normal bubble, because there’s no manic search for illusory profit. But perhaps a manic search for illusory safety qualifies…
I don’t think we’re experiencing a bond bubble. interest rates are where hey should be in comparison to NGDP growth and an output gap.
#4 and #2 are both correct.
your last sentence is absurd; real inflation inflation reduces the real household debt burden, and the only way the economy grows anymore is by increasing the household debt burden — this is in line with Larry summers’ recent speech.
when GDP growth outstrips wages for 35 years, bubbles are really the only way the economy can grow.
Yes, but one problem with 4. is that real estate prices are now rising, in some areas by a lot. Real estate is highly leverageable. Rising real estate prices show up in rising rent, and that suggests that CPI inflation may not be overstated. Personally I think some combination of all 4 are at work. Regarding item 1, I think the Fed does have some pull, or at least markets think the Fed has pull, which in the short to intermediate term, has real effects. An expectations game if you will.
Why should long term interest rates rise or be rising under a PSST model?
The ten year doesnt seem far out of line with real gdp growth looking back thirty years, except that it mostly underperforms. Answer me this, what is the relationship between the ten year and yearly real growth?
RE #3: Who’s to say current prices are irrational?
I’m not sure rates are mis-priced. To me, real short-term rates should be about 0…maybe very slightly positive. Why should idle risk-free cash earn a positive real return? So that leaves a modest term premium for taking duration risk….seems reasonable.