Low interest rates: They are not easy money, and they're here to stay
By Scott Sumner
In recent months the rest of the world has finally begun to accept the market monetarist view that interest rates are likely to stay low indefinitely. But there’s still a lot of confusion as to the reasons why. The Financial Times has a long article on the topic; here are a few excerpts:
“The emergency to pension schemes has been caused by QE,” she said. “I don’t see how it is reasonable to ask companies with pension schemes to fill a £1tn hole and put money into their businesses as well. It doesn’t add up.” . . .
“It’s scary and it’s surreal,” says Carsten Stendevad, who heads ATP, the $110bn national Danish pension plan. “First, if you’re in the business of offering annuities, your product just became very expensive to produce. But secondly we can see that the impact of QE is affecting other asset classes as well. That’s the scarier part. There’s nowhere really to hide.”
Who’s to blame for all this confusion? Not Milton Friedman, who said extremely low rates are a sign that money has been tight. I’d blame the Keynesians. Yes, this is a bit unfair, as the more sophisticated practitioners of New Keynesianism, such as Michael Woodford, always emphasize that interest rates don’t measure the stance of monetary policy—you need to compare market rates to the Wicksellian equilibrium rate. But in the end the public fails to absorb these nuances, and instead assumes that their EC101 textbooks were teaching them that low interest rates mean easy money.
Maybe they were.
Of course if that were true, then the Fed tightening of last December would have led to higher interest rates. Instead, bond yields have fallen sharply over the past 8 months.
David Beckworth has an excellent post on this topic, and shows that rates have remained low even as QE has been unwinding. He shows that the Fed’s share of total Treasury debt outstanding is now lower than back in 2007, before any QE had occurred. Here’s a graph from David’s post:
Keynesians need to try harder to explain to the public that low interest rates do not imply easy money. Otherwise policymakers looking for “solutions” to the pension crisis might end up enacting policies that make the “problem” even worse, as the ECB did in 2011, when it twice raised its target interest rate.