William Watson: Higher interest rates wouldn’t be shocking, of course

The low interest rates we have experienced in recent years were well below trend. So where do rates go next?

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Before, when people found out that I was an economist, they would immediately ask me, “So where are interest rates going? I have now come to an age where most people I meet have paid off their mortgages and the unnecessary chatter is now about the pains and careers of the kids. But for the world as a whole, the future of interest rates is obviously a major concern as central banks attempt to bring inflation back to the roughly 2% that we have grown accustomed to over the past three decades. So: how high will the rates go?

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Meteorologists, astrologers and economists. You probably have your own ranking of the most reliable predictions. But let me put a little pressure on economists: we at least bring discipline and data to the work, as well as caution about extrapolation.

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To know where interest rates are going, it is probably useful to have an idea of ​​their evolution. A recent article by Kenneth Rogoff, Barbara Rossi, and Paul Schmelzing provides perspective dating back to 1311. Rogoff, former chief economist of the IMF, is at Harvard, Rossi at the Barcelona School of Economics, and Schmelzing at Boston College and Hoover Stanford institution. . Schmelzing is a professor of finance but his doctorate (from Harvard) is in history and he was the one who put together the long time series of real long-term interest rates. You can download his data from the Bank of England and access a podcast with him produced by the Mercatus Center at George Mason University.

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The good news – depending on whether you are a borrower or a lender – is that real interest rates on long-term instruments from low-risk issuers are much lower than before. The first entry for the UK is for 1314 and it’s 13.4% which is heavy. (Who knows? Maybe Edward II, king at the time, had just gone through a “will or won’t I?”

By comparison, 10-year US government bond yields are 4% and US inflation is currently at 8.2%, so a rough estimate of US real long rates is minus 4%. Plus-13 versus minus-four: which would you rather pay?

Financial scholars generally date the birth of “a pan-European public debt market of long-dated assets” to the fourteenth century, following initiatives in the city-states of northern Italy during the Previous 150 years in which governments sold property from their tax revenues. in exchange for money now. Thus, Schmelzing’s 800 years of interest rate data roughly covers the known life of these assets. A chart of the data shows that the rates have gone up a lot. This latest paper with Rogoff and Rossi puts the time series through various econometric tests to see if it behaves consistently or changes drastically from one era to the next.

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It turns out it behaves pretty consistently over the eight centuries – which is surprising considering how much the world has changed since the 14th century. (Did you know they didn’t have cell phones?) The trend is down, which has been good for borrowers and for all of us who benefit from the economic activity they generate. And the downward trend seems fairly steady, at 160 basis points (or 1.6 percentage points) per century.

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The three researchers apply a number of tests intended to find breaks in the series, that is, places where its behavior seems to change. Looks like there is one in the middle of the 14th century, during the time of the Black Death. It’s reassuring in a way: you hope the markets notice when one-third to one-half of all people die. For a long time, in fact, economic historians thought that the resulting sudden increase in the capital/labour ratio (because buildings, land, and equipment remained even as millions died) may have helped spur the economic growth that ultimately gave us the Renaissance, the Enlightenment. , industrial revolution and modern times.

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There seems to have been another break in the middle of the 16th century, at the time of the “default of the Trinity”, during which Spain, France and the Dutch States-General went bankrupt, which threatened to his turn House Fugger, perhaps the most influential of all time. finance family, even more powerful than the Medici and the Rothschilds.

But many of the years that figure so prominently in our own worldviews — 1914, 1929, 2008 — don’t seem to have shaken the time series. In several countries that the researchers look at individually, 1937 and 1981 appear to have been key years, but their general conclusion is no: not much since the 16th century – when the curve flattened somewhat after a slightly steeper drop .

So where are interest rates going? The low rates we have experienced in recent years were well below trend. Which means that unless we experience another break in the series – which we won’t experience for another century or two – it wouldn’t be surprising if real rates returned to trend.

The other lesson the study teaches, though it’s more compelling for people whose mortgages are already paid off, is that the short-term ups and downs we obsess about have nothing to do with power. a trend of eight centuries. Believe me on that.



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Leslie M. Gill