Thursday, January 16, 2020

Centuries of interest rate data - Proves challenging for investors today

There are many explanations for the low interest rates we currently see around the globe. For markets focused analysts, it is the decline in bond market risk premia. For the macroeconomist, it is "secular stagnation", or some narrative around excess demand and supply. The general view is that low interest rates is a problem that has to be solved and it is something that is abnormal, and rates will eventually move back to normal with normal being higher. 

The research by Paul Schmelzing of the Bank of England in Staff Working Paper #845, "Eight centuries of global real interest rates, R-G and "suprasecular" decline, 1311-2018", provides an alternative narrative on levels of interest rates that is challenging for all economists and analysts. A study of real interest rates over centuries of data suggests that rates have been declining for hundreds of years. Current rates may not be abnormal.
  • The global low interest rates of today are normal. 
  • The trend in real interest rates has been going down for centuries. 
  • Negative real interests are not abnormal. 
  • Extrapolation for what rates may do using the last few decades is perilous and not informative.
  • The spike and decline of rates over the last 100 years is unusual.
  • The volatility of inflation and real rates has been abnormal.

There is power in economic history and looking at very long-run data. The author of this monumental work does not oversell his results although he makes some interesting references to the r - g Piketty debate on inequality by observing that the facts of high "r" relative to "g" are not on his side. 

What centuries of data tell us is that any extrapolative forecasting of what is long-term normal or what to expect with interest rates is fraught with peril. You can make your forecasts on what long-rates should do, but tell us why this time is different. 

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