Why Are Interest Rates So Low? (II)

Six years ago, I opined that

borrowers have become less keen about borrowing; that is, they lack confidence about future prospects for income (in the case of households) and returns on investment (in the case of businesses). Why should that be?

If the post-World War II trend is any indication — and I believe that it is — the American economy is sinking into stagnation. Here is the long view [growth rates are inflation-adjusted, final entry updated]:

  • 1790-1861 — annual growth of 4.1 percent — a booming young economy, probably at its freest
  • 1866-1907 — annual growth of 4.3 percent — a robust economy, fueled by (mostly) laissez-faire policies and the concomitant rise of technological innovation and entrepreneurship
  • 1970-2010 2018 — annual growth of 2.8 2.7 percent – sagging under the cumulative weight of “progressivism,” New Deal legislation, LBJ’s “Great Society” (with its legacy of the ever-expanding and oppressive welfare/transfer-payment schemes: Medicare, Medicaid, a more generous package of Social Security benefits), and an ever-growing mountain of regulatory restrictions. [All further compounded by Obama’s expansion of Medicare and Medicaid and acceleration of regulatory activity, some of which Trump has reversed, but most of which still throttles the economy.]

Arnold Kling, citing a piece by Andrew McAfee, suggests another reason:

[C]ould this decoupling [economic growth with less resource use] be responsible for low interest rates?… As long as economic growth required more use of resources, you expect a positive return from storing resources. You get a positive interest rate out of that. But when growth is decoupled, you do not expect a positive return from storing resources. If you want to create a store of value with a positive rate of return, you need to find some productive investment.

But storing resources is only part of the picture. The interest rates that producers pay depend on (a) what they expect in the way of future profits and (b) the availability of funds. Even if profitability is rising because of more efficient resource use, rates could be falling because — as a commenter on Kling’s post notes — there is a steady increase in global savings.

Why would that be? Because households (and businesses with large cash balances) have more disposable income as real incomes rise (and profit margins grow). Some of that increment is made available to corporate borrowers through direct purchases of corporate debt and purchases of mutual funds and ETF shares. Even historically low interest rates on corporate debt will attract buyers because the alternatives (low rates on bank deposits and money-market certificates) are worse.

So it would seem that the long-standing slowdown in the U.S. economy isn’t the whole answer to the question. But it remains part of the answer. Interest rates would be higher if the dead hand of government were lifted from the economy’s carcass.