Finance in the 21st Century
Shorting Fiscal Consolidation
Robert J. Shiller
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NEW HAVEN – Real long-term interest rates – that is, interest rates on inflation-protected bonds – have fallen to historic lows in much of the world. This is an economic fact of fundamental significance, for the real long-term interest rate is a direct measure of the cost of borrowing to conduct business, launch new enterprises, or expand existing ones – and its levels now fly in the face of all the talk about the need to slash government deficits.
Nominal interest rates – quoted in terms of dollars, euros, renminbi, etc. – are difficult to interpret, since the real cost of borrowing at these rates depends on the future course of inflation, which is always unknown. If I borrow euros at 4% for ten years, I know that I will have to pay back 4% of the principal owed as interest in euros every year, but I don’t know what this amounts to.
If inflation is also 4% per year, I can borrow for free – and for less than nothing if annual inflation turns out to be higher. But, if there is no inflation over the next ten years, I will pay a hefty real price for borrowing. One just doesn’t know.
Economists like to subtract the nominal government bond yield from the inflation-indexed bond yield of the same maturity to get a market estimate of the inflation rate from now to that maturity date. But such forecasts of “implied inflation” can be wild, if not absurd. During the heat of the 2008 financial crisis, for example, the inflation-indexed yield in the US rose so high for a brief period that implied annual inflation for the next seven years suddenly dropped to -1.5%. (A subsequent study by PIMCO bond traders Gang Hu and Mihir Worah concluded that this was linked to technical and institutional factors concerning the Lehman Brothers bankruptcy.)
The real reason inflation-indexed bond yields are an interesting economic variable is that they report on a market in which both investors and borrowers know exactly what is coming, in real terms. Notably, the issuer, that is the borrower, can rationally plan such borrowing to make real investments.
The supposed threat posed by government debt levels hasn’t hurt these markets, at least in the relatively few countries that have inflation-indexed bonds. Long-term inflation-indexed bond yields have fallen to around 1% a year, or less, in the United States, Canada, the United Kingdom, and the eurozone. Elsewhere, yields have been a little higher – around 2% in Mexico, Australia, and New Zealand – but still very low by historical standards.
All these countries have shown roughly the same downward trend in real interest rates for many years, and notably since 2000. If one were to extrapolate this trend, ten-year interest rates would move into negative territory in a few years or so for most of them. In the US and the UK, yields on intermediate-term (5-year) inflation-indexed bonds are already actually negative this year.
One may ask: how can an interest rate be negative? Why would anyone lend (buy a bond) for less than nothing?
One can never have negative nominal interest rates (except through some oddity of taxes or regulations), since lenders would rather hold their cash than effectively pay borrowers. But there is nothing to stop negative real interest rates, since routine investors may have no alternative risk-free instrument that offers a positive real return.
The low level of real interest rates does not appear to be due to the 2007-2009 financial crisis. In fact, there was a temporary upward spike in real long-term interest rates during the financial crisis in countries with indexed bonds. The rate has come down to low levels only during the period of recovery from the immediate crisis.
Instead, low long-term real interest rates appear to reflect a general failure by governments over the years to use the borrowing opportunities that the inflation-indexed markets present to them. This implies an arbitrage opportunity for governments: borrow massively at these low (or even negative) real interest rates, and invest the proceeds in positive-returning projects, such as infrastructure or education.
Opportunities for governments to do this exceed those of the private sector, which in many cases continue to be constrained by slow economic growth. Moreover, unlike private firms, governments can count as profits on their investments the benefits of positive externalities (benefits that accrue to everyone).
Surely, governments’ levels of long-term investment in infrastructure, education, and research should be much higher now than they were five or ten years ago, when long-term real interest rates were roughly twice as high. The payoffs of such investments are, if anything, higher than they were then, given that many countries still have relatively weak economies that need stimulating.
It is strange that so many governments are now emphasizing fiscal consolidation, when they should be increasing their borrowing to take advantage of rock-bottom real interest rates. This would be an opportune time for governments to issue more inflation-indexed debt, to begin issuing it, or to issue nominal GDP-linked debt, which is analogous to it.
Robert Shiller, Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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Ed 10:03 19 Nov 10
I like this idea and reasoning of Shiller’s. And of course it is built on “real is what counts”. Giving an opportunity to show very instructive real asset price histories, e.g.:
“Real Homes, Real Dow” at
http://homepage.mac.com/ttsmyf/RD_RJShomes_PSav.html
which powerfully illustrate “real is what counts”. Surely, bubbles-shown dictates bubbles-deterred.
farfetched 10:07 19 Nov 10
When Nations and Systems Forget the Real Game
One can assume the Power Elite can affect a nation or an single retirement fund to become squeezed and somewhat oppressed in this current Austerity Environment. They say, market forces cleanse wasteful investments, innovative business models make existing ones obsolete, and the economy roars forward all the stronger for it--or do the Magicians of the Oligarchy running the show from behind the curtains blind us?
Make no mistake of these well crafty Magicians trying to control the currency and banking systems of the world behind the backdrop of the world's curtain. Enough money to invest and control nation's choices and to bring nations to be introduced to the New World of Austerity Investing rules. However, while market entrepreneurs generally prosper during times of great dislocation, ultimately to the benefit of all participants in the economy, today political entrepreneurs have hijacked the economic system.
The politically connected elites have used this downturn to carry out a massive wealth transfer from the people, to the public, and private sectors; fleecing the middle class for their own enrichment. In their hypocrisy, the long ago small businesses that grew large because of free markets have helped chain these markets through lobbying for regulations and subsidies to shield themselves from competition and their own errors.
In these times of greater uncertainty, messages are sent to play on the field with rules of engagement. This message was sent with Ben Bernanke on Friday November 19 to China and the Asian Rim. There is even a more important message being sent to Congress and the President of Barack Obama from these uttered concerns.
It is a siren to the governments around the world to hold accountable, the corporations filing their 10-Ks, and other formal filings showing they have achievable documented earnings reaching the highest level on their books in the history of their businesses since the stock markets opened their doors.
Understand the dominator of Abyss factor keeps the housing recovery from total collapse is based upon 2 1/2 million unemployed just in the United States keeping their benefits extended in Unemployment and COBRA for another 12-month period. The catch for Congress and the President Obama is to charge this off to the corporation structures revealing their buy back of shares and upping their dividends at the expenses that dislocated all these millions of folks in the first-place.
The facts are clear; you take out the one direct source of pure stimulus of home-modification support for payments extended through the unemployment and COBRA, Extended Medicaid benefits. These benefits staying in the equation, getting these folks still supporting an economic consumption of basic necessities, and combining part-time dollars from possible one working individual, may be the only piece of the puzzle working right through this whole mess.
The basic facts are simple in keeping as many Americans within their homes may play out to be crucial to a housing and economic recovery. Keeping them out from under the foreclosure mess of to many units flooding the markets and the up keep would cause the markets to depress even further than the 25% expected by Case-Schiller within Professor Robert Schiller most recent written responses giving solutions on-going for the housing and unemployment problems.
If these extension for benefits to these 2 1/2 million folks on the table of the United States approving or disapproving could add up to be an Atom Bomb. Atomic bomb of inviting the Abyss theme as bantered about by so many brilliant minds. If these 2 1/2 million folks are not approved, as calculated within the Coase Oppression (Austerity Theorem), by well respected and renowned formulas. We all face cataclysmic failure of collapsing the China and Asian Rim and other nations by the mere fall-out of the bomb becoming lit and sent flying like an missile with all nations becoming the target of its wrath.
An Atomic Bomb accidentally lit by ignorance of an Oligarchic miscalculation in timing of letting these unemployed folks, numbering well into around 2 1/2 million. These folks no longer stay within their homes under pre or post foreclosure or home modification status.
These same folks with the additional folks from other nations supporting the delicate consuming economies of CPIs, GDPs and other essential growth metrics based upon the wellbeing of the Human unit bantered about by noted Professor Joseph Stiglitz. His theorems are well versed to be incorporated in measuring the wellbeing of economic survival of a nation. Nations ensuring a recovery can be substantiated.
Greece, Ireland, and eventually other nations pressing the ECB an IMF need to stretch multi-trillion dollar debt restructures until the balance of the "New Third Wave Austerity Industries" bring many of the nations to become self supportive again, based upon an increase, and not a decrease, in Birth rates; as Demographic Economics is also more than at play.
In plain English; these folks going to lose their, Unemployment and extended COBRA benefits starting in December of 2010 are the match that will be remembered around the world that a Tea Party, Republican, Democratic, and/or independent did not think long and hard about what history is going to write about them in the Year of December 2010. The collapses that occurred henceforward going into 2011 and steering full speed ahead into 2012s and collapsing China and all the other Emerging Growth Nations to hyper-deflation to try to allow for basic survival needs to be met by all under Coase Oppression (Austerity Theorem).
Far-fetched, No, not this time. I wish it were! However, the math does not lie on the affects of 2 1/2 million Americans coming into the free-fall of losing their benefits. Benefits toppling the balance as stated hopefully as clearly as can be stated, causing the fall of many home modifications and contractual holding patterns of debt structural easing as seen demonstrated by QE1, QE2, and eventually, QE3.
Collapses further denigration of the homes coming into the status of foreclosure deeming the effects of a downward pressure of the current markets supporting all the Municipal Bond Issues stemming from Cities, Counties, and States. No differences from the issues of Greece and other nations being no larger than California or Texas combined.
I announced onetime as attached article answering the origins of creation and Stephen Hawking claims of some concerns for many. To get to know Teleios and the "I am" of your origins of what makes you the you or your "I am".
May the peace of the coming days be with all reading this plea for sending a message straight to Washington and the World leaders...
AHS 12:14 30 Nov 10
Minor point: I think the calculation of estimating expected inflation is backwards. I believe most economists subtract inflation-index yields from nominal yields to get a market estimate of the inflation rate.
Major point: While investing at low real interest rates in infrastructure that has a higher return may be good economics, isn't there a financial risk that growth in government revenues do not match inflationary growth if it matches or exceeds the market's expectations?
Joulie 10:07 18 Nov 10
Ce raisonnement peut être valable aux USA mais certainement pas en Europe. En effet, l'économie européenne est dominée par des dépenses publiques très lourdes et une faiblesse de l'esprit d'entreprise. Les taux d'intérêts à long terme sont très bas aussi à cause de la peur des marchés financiers à l'égard des actions, il y a report des capitaux des actions vers les obligations. Profiter de taux bas convient à la société américaine qui se fonde sur l'esprit d'entreprise mais ne convient pas à l'Europe ou les déficits sont colossaux et stériles.
Bien cordialement,
benoit.