Sunday, February 23, 2020

The history of interest rates – the 700 year decline [Infographic]

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Currently we live in a low-interest-rate environment, where the cost of borrowing for governments, institutions and investors is lower than the historical average.

It is easy to see that interest rates are at generational lows, but did you know that they are also at 670-year lows?

In the following graphic from Visual Capitalist, Paul Schmelzing, visiting scholar at the Bank of England (BOE), shows how global real interest rates have experienced an average annual decline of -0.0196% (-1.96 basis points) throughout the past eight centuries.

Visualizing the 700-Year Decline of Interest Rates

Source: Visual Capitalist

 

The Evidence on Falling Rates

Collecting data from across 78% of total advanced economy GDP over the time frame, Schmelzing shows that real rates* have witnessed a negative historical slope spanning back to the 1300s.

Displayed across the graph is a series of personal nominal loans made to sovereign establishments, along with their nominal loan rates.

Some from the 14th century, for example, had nominal rates of 35%.

By contrast, key nominal loan rates had fallen to 6% by the mid 1800s.

Centennial Averages of Real Long-Term “Safe-Asset”† Rates From 1311-2018

% 1300s 1400s 1500s 1600s 1700s 1800s 1900s 2000s
Nominal rate 7.3 11.2 7.8 5.4 4.1 3.5 5.0 3.5
Inflation 2.2 2.1 1.7 0.8 0.6 0.0 3.1 2.2
Real rate 5.1 9.1 6.1 4.6 3.5 3.4 2.0 1.3

*Real rates take inflation into account, and are calculated as follows: nominal rate – inflation = real rate.
†Safe assets are issued from global financial powers

Starting in 1311, data from the report shows how average real rates moved from 5.1% in the 1300s down to an average of 2% in the 1900s.

The average real rate between 2000-2018 stands at 1.3%.

Why have interest rates been trending downward for so long?

Here are the three prevailing theories as to why they’re dropping:

1. Productivity Growth

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Since 1970, productivity growth has slowed.

A nation’s productive capacity is determined by a number of factors, including labor force participation and economic output.

If total economic output shrinks, real rates will decline too, theory suggests.

Lower productivity growth leads to lower wage growth expectations.

In addition, lower productivity growth means less business investment, therefore a lower demand for capital. This in turn causes the lower interest rates.

2. Demographics

Demographics impact interest rates on a number of levels.

The aging population—paired with declining fertility levels—result in higher savings rates, longer life expectancies, and lower labor force participation rates.

In the U.S., baby boomers are retiring at a pace of 10,000 people per day, and other advanced economies are also seeing comparable growth in retirees.

Theory suggests that this creates downward pressure on real interest rates, as the number of people in the workforce declines.

3. Economic Growth Economy Australia

Dampened economic growth can also have a negative impact on future earnings, pushing down the real interest rate in the process. Since 1961, GDP growth among OECD countries has dropped from 4.3% to 3% in 2018.

Larry Summers referred to this sloping trend since the 1970s as “secular stagnation” during an International Monetary Fund conference in 2013.

Secular stagnation occurs when the economy is faced with persistently lagging economic health. One possible way to address a declining interest-rate conundrum, Summers has suggested, is through expansionary government spending.

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from Property UpdateProperty Update https://propertyupdate.com.au/the-history-of-interest-rates-the-700-year-decline-infographic/

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