World Real Interest Rates: A Tale of Two Regimes

Global real interest rates were driven up in the 1980s, partly to encourage disinflation, while subsequently structural and conjunctural factors have driven rates to lower levels. The increase in the global pool of savings and the fiscal correction associated with the long economic expansion from 1992 to 2007 had put downward pressure on real rates and the extraordinary monetary policy responses since 2008 have sustained that trend into negative territory. The initial consequences of low real rates in the early part of this century had been to elevate asset prices, promote leverage in financial institutions and, as a counterparty, increase private sector indebtedness. The management of deleveraging by policymakers implies setting a low path for real rates along the yield curve by using a combination of traditional and non-traditional monetary and fiscal policies for as long as the economic dislocation persists. Facing a public and private debt overhang, low real rates help the adjustment of global balance sheets but cannot be driven low permanently by policymakers. My analysis suggests that there are two regimes for real rates; those for normal times are positive and vary with the global economic cycle, while those that deal with economic dislocation are negative. Once growth is secured, real rates will rise quickly to more normal levels, not least because, in order to limit any increase in funding costs that may result from capital inadequacy (apparent or real), banks themselves have a considerable appetite for capital, and that will also start to crank up real rates given a fixed pool of savings. It therefore seems likely that, over the medium term, real yields are likely to be in the range of 2-4%, rather than their current levels.