This week former Fed chief Ben Bernanke started a blog hosted by the Brookings Institution, and his first week of posts concerns the subject of—wait for it now, I know it will come as a big surprise . . . interest rates. In the first of a series of three posts this week, Helicopter Ben makes the point that interest rates are driven chiefly by economic fundamentals. Well knock me over with a feather!
Low interest rates are not a short-term aberration, but part of a long-term trend. . . If you asked the person in the street, “Why are interest rates so low?”, he or she would likely answer that the Fed is keeping them low. That’s true only in a very narrow sense. The Fed does, of course, set the benchmark nominal short-term interest rate. The Fed’s policies are also the primary determinant of inflation and inflation expectations over the longer term, and inflation trends affect interest rates, as the figure above shows. But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.
Nothing especially remarkable here (in fact Blogging Ben goes on to say “This sounds very textbook-y, but failure to understand this point has led to some confused critiques of Fed policy”), but Randall Forsyth notes in Barron’s this morning that this represents a change in Bernanke’s account of How The World Works:
In November 2010, the then Fed chairman wrote a Washington Post op-ed article to explain why the central bank was buying hundreds of billions of dollars of government securities. The answer, according to his defense of the central bank’s policy moves, was to lower long-term interest rates.
At this point, Bud Collyer, the bow-tied emcee of To Tell the Truth, would exclaim, “Will the real Ben Bernanke, please, stand up!”
Is it the Bernanke who now insists that central banks have no influence over long-term interest rates? Or the other guy, who argued four-plus years ago that the Fed was undertaking unconventional policies in order to drive down long-term rates?
In his Washington Post op-ed, Bernanke explained the central bank’s decision to undertake a second round of securities purchases, dubbed QE2. The first buy of more than $1 trillion had “helped reduce longer-term interest rates, such as those for mortgages and corporate bonds.”
Moreover, the expectation of QE2 already had been felt in the easing of financial conditions. “Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action,” he wrote.
In other words, it would appear that Bernanke, the Fed chairman, was taking credit for lowering long-term interest rates in 2010—something that Bernanke, the academic, contends in 2015 that the central bank cannot do.
Nice catch by Forsyth, but he adds some additional details that add up to the likelihood of continued easy money, contrary to what the Fed keeps saying about getting ready to boost short-term rates some time soon. First, note yesterday’s terrible jobs report. But more interesting is the factoid that there are now $5 trillion—that’s with a “t”— of debt securities worldwide trading at negative interest rates. Add to this the continued volatility of oil prices (and the prospect of a near-term price collapse if the Iranians flood the market with newly un-embargoed oil), and. . .
Hard to see how this doesn’t end badly.