Real Interest Rates Are A Wrench In The G 7's Recovery

Why hasn't the big drop in interest rates in the industrial world spurred more growth? One key reason is that while market rates have come down sharply, real interest rates--the interest rate minus inflation--still are high in most countries. In the U.S., the recent plunge in rates brought the real interest rate on 10-year bonds down to about 2.5%. That's close to its post-war average and lower than it was for most of the 1980s.

But even with Japan's latest discount-rate cut, real interest rates across much of the world are still startlingly high. Japan, with a 3.9% interest rate and 1% inflation, has a real rate of 2.9% on its 10-year bonds. France has a 3.9% real rate, and Britain, with a 7% interest rate and a 1.3% inflation rate, has a real rate of 5.7%.

Until these real interest rates drop further, faster growth will be hard to achieve. In a recent report, Steven Nagourney, head of global strategy at Lehman Brothers Inc., notes that "the Group of Seven real-bond yield, now at 2.9%, compared with 3.4% two months ago, remains too high" to revive the world economy.

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