Global interest rates have been in decline for the past 30 years, but a growing number of economists argue that this could soon be about to change.
As a recent presentation by Charles Bean, president of the Royal Economic Society, former deputy governor at the Bank of England, and professor at the London School of Economics, illustrated, the world real interest rate (or the "neutral rate") has fallen from around 4 percent in the early 1990s to around zero today.
Bean's LSE colleague Charles Goodhart argues that this trend has been caused by the influx of low-cost workers into the global labor market from emerging markets pushing down labor's share of income.
As this labor glut has been used up, however, and as wages in emerging markets have begun to rise, this trend should start to reverse. At least in theory.
Goodhart writes that a combination of an aging global population and tightening global labor market should help improve labor's bargaining power, pushing up both wages and the neutral interest rate.
Ageing populations almost by definition will be less thrifty; the household savings ratio will fall. What we have argued above is that the ex-ante desire to invest may fall somewhat, but almost certainly less than the ex-ante desire to save. The obvious, indeed almost inevitable, conclusion is that real rates of interest will reverse from their present decline, and go back up. The current negative real rate of interest is not the new normal; it is an extreme artefact of a series of trends, several of which are coming to an end.
Toby Nangle, head of multi-asset management at Columbia Threadneedle Investments, has also written on the subject and agrees with Goodhart's sentiments.
"The global labor glut is coming to an end," Nangle said. "My best guess is that the tendency of the neutral rate from this point will be to rise."
Goodhart and Nangle contend that as the cost of labor increases, the incentive for businesses to substitute investment in new machinery or technology for cheap workers could start to unwind. Higher levels of investment would increase capital intensity and hopefully provide the boost to productivity that much of the developed world has lacked in recent years.
If right, that has important implications for investors -- most notably that traditionally safe assets, such as government bonds, could become much more correlated with risk assets such as equities.
Yet there are competing theories for falling real rates.
Among the most prominent is the secular stagnation thesis advanced most recently by Harvard economist Larry Summers, which suggests that falling real rates are the product of demand-deficient economies running permanently below potential and, as such, are set to remain low for the foreseeable future.
Unlike secular stagnation, the Goodhart/Nangle thesis, if right, should start becoming evident in the data over the next two to five years rather than over the next few decades. Not everyone is confident that it will, however.
Jamie Murray, an economist at Bloomberg Intelligence, said a number of key factors are likely to influence the trajectory of the neutral rate.
"Long-term real interest rates are low at the moment but there are four reasons they might not stay that way: 1) A global demographic inflection point is approaching; 2) Stronger growth might give central banks more room to unwind asset purchases; 3) Credit spreads could narrow, leaving space for higher policy rates; and 4) Faster trend global productivity growth could prove the doom-mongers wrong."
The central problem, Murray said, is that you cannot directly measure demographic effects on the neutral rate because it is impossible to disentangle them from the policy side.
Significant uncertainties remain over whether currently underutilized labor markets in India and across Africa will add significantly to the labor supply over the next few decades, holding back gains in the neutral rate.
Moreover, assuming that the trend pace of productivity growth will remain broadly the same as we have seen over recent decades relies heavily on the global institutional setup allowing investment to be channelled into productive regions and industries. The implied model also makes assumptions about governments' fiscal response to providing for aging populations.
Bean also points out that the the zero lower bound of central bank interest rates raises the risk that economies will run significantly below potential for extended periods of time, which can cause longer-term damage to output.
Jeremy Lawson, chief economist at Standard Life Investments, said isolating the demographic effects allows for only a partial analysis of the drivers of the neutral rate.
"I wouldn't dispute that the surge in global labor supply is likely to slow significantly, but how that interacts with real equilibrium interest rates is a more complicated question," he said.
"You may get some more real wage growth, but if it isn't matched by productivity growth, you can get higher inflation with weak real GDP growth. In other words, you may find that the composition of the real yield changes but not the neutral rate itself."
In short, the Goodhart/Nangle thesis may be an interesting way to conceptualize the falls in real interest rates over the past few decades and why some of the drivers of this trend may soon start reversing.
How far and how fast this process is likely to happen, however, remains subject to significant uncertainty, and thus investors might choose to treat expectations of rate normalization to 1980s' levels with caution.