DeLong on interest rates
There’s an interesting piece by Brad DeLong in Saturday’s Australian Financial Review, which I can’t find anywhere online.He lists four reasons why interest rates can be expected to rise in the future. The first two are just two facets of the same thing – the embrace of deficit finance by the US Republicans in both Congress and the executive branch. The third is closely related: the failure of Western European governments to address the coming fiscal crisis associated with retirement income policies. All of these are currently being offset by the willingness of the Chinese and Indian central banks to buy US and Euro bonds in an effort to maintain competitive exchange rates. But this can’t last forever.
The fourth factor is “the inability of Western European governments top enact sufficiently bold liberalising reforms to create the possibility of full employment, together with the failure of Western European monetary policy to be sufficiently stimulative to create the reality of full employment”. I have some doubts about this. Leaving aside any questions about the efficacy of “liberalising reforms”, it’s far from clear that the adoption of stimulatory monetary policy in the short run is conducive to low nominal interest rates in the long run. I would have thought that just as stimulatory deficits in a recession need to be offset by larger surpluses during booms, an active monetary policy implies a larger variance in interest rates over the cycle.
More significantly, it seems to me that, on a crucial point Brad has the argument backwards. He says “Believers in low interest rates … point to rapid technological progress, which has boosted output.” In general, technological progress ought to create new investment opportunities at high rates of return, while the associated increase in asset values should raise current consumption. This should raise the real rate of interest, not lower it. In fact, this is precisely the argument Brad makes in relation to India and China.
On checking, I was surprised to find out that the ratio of nonresidential gross investment to US GDP is near an all-time low, at 10.0 per cent (you can get the data from the Bureau of Economic Analysis . Taking account of the increasing share of computers and software, which have high depreciation rates, it seems likely that the net investment share is lower than ever. Maybe this can be explained if all the technological progress takes the form of capital-saving reductions in the cost of computing and telecommunications. This would reduce demand for capital (but ought to increase demand for labor, something that has evidently not taken place).