Welcome to the Era of Incompetence

Two diametrically opposed scenarios exist for what will happen to global real interest rates over the next generation.

Those who predict generally low interest rates over the next generation point to rapid growth of productivity and potential output in the world economy. According to this view, the principal problem faced by central banks will not be restraining demand as it shoots above potential, but boosting demand as it lags behind potential. They point to the fact that the world's major central banks - the Federal Reserve, the European Central Bank, and the Bank of Japan - have so firmly established their anti-inflation credibility that the inflation risk premium has been wrung out of interest rates.

Believers in low interest rates also emphasize shifts in income distribution in the United States away from labor and toward capital, which have greatly boosted firms' resources to finance investment internally and reduced their dependence on capital markets. They point to rapid technological progress, which has boosted output from new and old capital investments. With competition strong across the economy, they say that we can look forward to a generation of relatively high asset prices and relatively low real interest rates worldwide.

By contrast, those who predict generally high real interest rates over the next generation point to low savings rates in the US, high spending driven by demographic burdens in Europe, and feckless governments running chronic deficits and unsustainable fiscal policies. Imagine a bunch of irresponsible Bush-like administrations making fiscal policy, forever.