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Could low interest rates stick around?

? The Budget: Not Serious Yet About the Environment |


| Permanent flattening of the yield curve? ?

February 12, 2007

Could low interest rates stick around?

Michael Mandel

My colleague David Henry and I wrote BW's current cover story, making the case that low rates could last longer than expected. The downside? Financial excesses, which we are already seeing.

Read the story, "It's A Low, Low, Low, Low-Rate World," here.

08:54 AM

Financial markets

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? The Long Arm of the Laws of Economics from The Webquarters

Since prehistoric times, a simple principle has held true: if you lent money to somebody, you would demand a return high enough to justify the risk of that person defaulting on the loan. There is now evidence that the risk premium on junk bonds has s... [Read More]

Tracked on March 2, 2007 05:20 AM

Time to ramp up on OPM while it's practically free. When these stars are no longer aligned, those who haven't are going to be sorry.

Posted by: Brandon W at February 12, 2007 01:57 PM

It really indicates a dearth of investment opportunities, which doesn't portend a bright future.

Posted by: Lord at February 12, 2007 02:59 PM

Maybe we sometimes reach a moment where people's appetites to build and consume are exceeded by their ability to earn. Eventually people define a whole new standard of living that swallows the available capital and leads to higher rates. For example, if the upper middle class started to invest in personal aircraft at say a rate of 30% to 50%, (of that population) that would eat up huge amounts of capital that is currently seeking places to be spent. Of course we have no idea what people will use to define the next level of consumption. Aircraft might be next because many single people, couples and families of 3 or 4 havn't yet found use for houses bigger than 2400 square feet. Then again maybe the next big ticket item of popularity has yet to be invented or maybe our next item will be something that goes in the home and the home will have to be bigger to hold it.

Posted by: Joe Cushing at February 13, 2007 12:56 AM

Joe, that's an interesting suggestion, but how then do you explain the negative savings rate? It is the worst since the Great Depression. Doesn't that suggest that peoples "appetites" are already exceeding their ability to earn?

Posted by: Brandon W at February 13, 2007 08:27 AM

Could interest rates be running so low because of the 1996 Boskin Commission, and the impact it has had on lowering the reported inflation so substantially?

I note the impacts here (borrowed, not my own):

The main recommendations of this commission were:

1. Publish two indexes - the CPI and the core rate, which excludes the cost of energy and food. This way when the core rate is reported it is almost invariably reported as lower than the CPI. The politicians like to trout out this number, though it is fictional only since I don't know anyone who doesn't have to buy food or energy (which by the way is the same thing).

2. Change the fixed weight formula for a geometrically weighted one for CPI goods - this has the effect of giving a lower weighting to those items that are rising in price and a higher weighting to those falling in price.

3. Introduce substitutions into the index - if people couldn't afford to buy beef, then they would switch to chicken, if chicken got too expensive, then they would select fish, and so on and so on...until maybe we all will be eating berries in the woods.

4. Introduce seasonal adjusmtents to smooth out price fluctuations - like home heating oil spikes in the winter and summer gasoline price spikes. Only problem is that price spikes are not recorded, whereas sharp declines are so that the CPI gets adjusted lower.

5. Manipulate prices through hedonics, which essentially adjusts prices based on the increased pleasure derived from a product

Posted by: Brandon W at February 13, 2007 03:22 PM

Brandon W,

Our negative savings rate is a local issue that directly results from the excessive savings of others on the other side of the world. Also I don't think our negative savings rate takes into account unrealized capital gains on homes that people are spending through loans. During the depression these gains didn't exist.

Maybe it's not about the next big wave of increase in our standard of living. Maybe its about the developing world's appetite for consumption and construction doing some catching up with ours.

Posted by: Joe Cushing at February 13, 2007 04:45 PM


The negative savings rate comes about, in part, because investments like education and government R&D are counted as consumption in the national income accounts. To put it a different way, when Mike Bloomberg gave Johns Hopkins University $100 million last year, that counted as personal consumption and depressed the personal savings rate. Go figure...

Posted by: Mike Mandel at February 15, 2007 11:06 AM

Do you see real rates falling even further from here? Will we see even more hoarding?

Posted by: Lord at February 19, 2007 06:03 PM

Take two matured economic entities, Japan and US, as examples. The permanent trade surplus country Japan has very low interest rates, whereas the persistant trade deficit country USA has substantially higher interest rates than Japan. One way to look at is that the interest rate difference is keeping Dollar artificially inflated against Yen, so US can continuesly run trade deficit and Japan can keep running trade surplus. For a matured economy like Japan, running trade deficit is equivalent to lend its own saving to US consumers to spend, so Japan's personal consumption will stagnate, and inflation will turn into deflation; there will be no pressure to raise interest rates. It is a vicious cycle for Japan. US can run negative saving rate since it is borrowing from foreigners in the form of massive trade deficit. As long as foreigners are willing to lend and support US consumers, this strange situation created by globalization can continue for quite a while.

Posted by: CK at April 7, 2007 11:50 PM

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