The Bank of England will say next week that it is leaving Bank rate unchanged. While it might hint at a rise later this year – Brexit permitting – this means we face another year, and maybe much more, of negative real interest rates.
What’s notable, though, is that super-low rates are having almost none of the effects one would ordinarily expect. Usually, we’d expect to see them cause a house price boom, but the Nationwide says prices rose only 0.5 per cent last year. We’d also expect to see an investment boom, but business investment has flatlined since 2014. And there should be increased household borrowing but consumer credit growth is slowing and insofar as it was high a few months ago it was a response to falling real wages. Super-low rates should also be inflationary, but CPI inflation is a mere 2.1 per cent. And you don’t need me to tell you that there’s been no stock market bubble of the sort often associated with low rates.
Granted, some of this is the effect of Brexit uncertainty. But by no means all. Capital spending, for example, fell way short of expectations before the Brexit vote in 2016.
Pretty much the only reason for rates to rise is that (officially measured) unemployment is low and wage inflation is edging up. But this itself is odd: low rates should encourage companies to replace labour with capital, and yet the opposite has happened.
If you knew everything about economic data except the level of interest rates, you wouldn’t guess that they have been rock bottom for years.
What all this tells us is that real interest rates might be close to their equilibrium level, which means that negative real rates might be sustainable for a long time precisely because they are not stoking up the booms we usually associate with low rates.
There are good reasons why the equilibrium rate might have fallen so much since the 1990s. We can see them if we think of rates as being determined by desired savings (which reduces rates) and desired investment (which raises them). Desired savings have risen because of an ageing population and fiscal austerity. And companies also want to save more. Increased amounts of intangible assets means companies have less collateral to borrow against and so must save more to be self-financing. Memories of the crisis have exacerbated this: the fear that credit will be withdrawn when companies need it has encouraged them to save more. (Note that what matters here is desired savings: these do not translate into actual savings because of the paradox of thrift.)
On the other hand, desired investment has fallen. There are countless reasons for this, among them the fact that the 2008 crisis reduced animal spirits; that companies fear that today's investments will be undercut by cheaper technologies in future; or that prices of IT-related goods has fallen and demand for them is not especially price-elastic.
If all this is right, it’s terrible news for savers. Almost all these factors except for fiscal austerity are structural ones that won’t disappear quickly – although some might fade slowly. Which means we could face many years of negative or nugatory real interest rates.
So what hope do we have besides an end to fiscal austerity? One is that economists actually know much less about equilibrium real interest rates than you might think. Jo Michell at Bristol Business School has enumerated 29 different theories, and Oxford University’s Christopher Bliss has said that all the main ones "suffer from serious defects". M&G’s Eric Lonergan adds that there might not even be an equilibrium rate at all. Such uncertainty means we cannot be confident that real rates will stay very low for very long even though it’s difficult to see what will increase them by much.
