From a financial point of view, 2022 was above all the year of the rise in interest rates.
It is true that the Federal Reserve it did not begin to raise the short-term interest rates it controls until March, and its foreign counterparts acted even later.
But the interest rates long term, which are the most important to the real economy, have been rising since the beginning of the year in anticipation of central bank movements.
These rising rates correspond, by definition, to falling bond prices, but they have also helped drive down the prices of many other assets, from shares in cryptocurrencies and, according to the first indications, the houses.
So what will the Fed do next?
How high will the rates go?
Well, there is a whole industry of financial analysts dedicated to answering these questions and I don’t think I have anything useful to add.
What I want to talk about instead is what is likely to happen to long-term interest rates.
Many commentators have argued that the era of low interest rates is over.
They insist We will never go backThese are the historically low rates that prevailed in late 2019 and early 2020, just before the pandemic, rates that were actually negative in many countries.
But I don’t see that happening.
There were fundamental reasons why interest rates were so low three years ago.
Those fundamentals haven’t changed; if anything, they got stronger.
So it’s hard to see why, once the dust of fighting inflation has subsided, we won’t be returning to a world of very low rates.
Some background: The low interest rates that prevailed just before the pandemic were the end point of a downtrend in the three decades.
What do we think caused this trend?
Some commentators argue that it was artificial for the Fed to keep lowering rates by printing money.
But basic macroeconomics says this shouldn’t be possible:
if you keep rates artificially low for an extended period, the result should be high inflation.
And until the 2021-22 price hike, inflation remained subdued year over year.
A useful concept here, which dates back more than a century to the work of the Swedish economist Knut Wicksell, is that of the so-called natural interest rate.
Wicksell defined the natural rate as the interest rate that equates saving with investment or as the rate consistent with general price stability.
In fact, these definitions are consistent with each other: an interest rate that is too low, so that investment spending exceeds the supply of savings, will lead to an inflationary overheating of the economy.
And the fact that we have not seen a inflationary overheating over a 30-year trend of falling interest rates suggests that the fall it wasn’t artificialthat the natural rate must have decreased during that period.
Why might the natural rate have decreased?
The most likely culprit is a decrease in demand of investment, driven by a combination of demographic and technological stagnation.
The key insight is that investment spending is largely driven by growth:
growth in the number of workers and technological progress.
A growing workforce needs more office space, more homes, etc .; a stagnant workforce only needs to replace structures and equipment as they wear out.
Technological progress can also help investments by making their replacement worthwhile obsolete capital goods and also enriching people so that they can require more space to live, etc. if technological progress slows down, investment spending tends to decrease.
Since the 1990s, these two investment incentives have lost much of theirsyou power up.
Once the last of the baby boomers reached their 20s, the number of Americans in their first years of employment, which had been rapidly increasing for decades, It has stabilized.
This demographic recession has been even stronger in other rich countries.
The working age population in Europe was decreasing since 2010, and in Japan it has been declining at a fairly rapid rate.
Technological change is harder to pin down, but it’s hard to escape the feeling that great innovations are becoming increasingly rare.
When was the last time you were excited about the latest iPhone?
Okay, some of us never have been, but still.
And for what it’s worth, productivity estimates Factor totals, a measure intended to capture the overall technological level of the economy, have grown slowly since the mid-2000s.
So is there any reason to expect demographics or technology to be more investment-friendly in, say, 2024 than in 2019?
I do not see it.
It is true that there have been many recent technological advances in green energy, and it is possible that an energy transition, aided by Joe Biden’s climate policies, will contribute to investments in the coming years.
But other than that, the same factors that kept interest rates low before pandemic they seem to still be there.
What do you think about inflation?
Another old principle for thinking about interest rates is the Fisher effect, which implies that an increase in expected inflation would normally lead to an equal increase in interest rates.
And inflation has skyrocketed over the past year and a half.
That spike is, however, likely temporary.
There is a lot to be said about inflation, but the outlook at 10,000 meters is as follows:
During the pandemic crisis, governments provided massive aid to families to maintain their income in the face of the economic blockade.
This meant that consumer purchasing power remained high despite a temporary reduction in production capacity, causing prices to rise and forcing central banks to raise rates. reduce inflation.
But there doesn’t seem to be much doubt that they will, in fact, control inflation.
Of course, financial markets expect inflation to return to pre-pandemic levels.
In short, therefore, the low interest rates were not artificial; they were natural.
And it’s hard to see anything that could cause the natural rate to rise once the current inflation spike is over.
So the era of low interest rates is probably not over after all.
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