In today's Wall Street Journal (page A1 in the print edition), reporters Greg Ip, Sebastian Moffett, and Jon Hilsenrath ask if the era of low interest rates has come to an end. Here's the theme:
As signs of inflation, spurred in part by soaring energy prices, surface around the world, central banks are signaling that the era of unusually cheap credit is coming to an end. The implications for markets and the world economy are significant: Investors may retreat from risky assets and air could leak out of the global housing boom. A recession seems unlikely but can't be ruled out since world central bankers seem determined to raise rates as much as needed to keep inflation low.
The authors, of course, have seen this picture...
... and are sort of forced into this observation:
The Fed has raised its short-term rate target from a 46-year low of 1% last summer to 3.75% now. The central bank has signaled it plans to keep going. Its actions so far have done little to slow the economy, in particular housing. That's largely because long-term bond yields, which are set by markets and influence mortgage rates, have remained unusually low in the U.S. and around the world. Precisely why is a mystery.
What difference will it make if other central banks follow the lead of the Federal Reserve (and the Bank of England)?
One possibility is that the supply of capital, or global savings, is high right now, while the demand for it -- investment -- is low. Thus, interest rates, the price of capital, have fallen. That is not likely to change much soon.
Another is that the prolonged period of easy global monetary policy has forced investors to accept lower long-term bond yields, especially in the U.S. If so, a move to tighter global monetary policy could finally produce the long-predicted rise in bond yields and slowing in housing, both in the U.S. and elsewhere.
I'm inclined to believe that, if the conditions in the first possibility are "not likely to change much soon", "tighter global monetary policy" is not going to bring the low interest-rate era to a close. At least not for long.
Here's a picture of long-term inflation expectations derived from Treasury inflation-protected securities (TIPS):
Note the relative stability of expected inflation over the period since the FOMC began raising the federal funds rate target. That says to me that these rate changes have been the necessary adjustments -- at least the adjustments perceived to be necessary -- to keep inflation contained to the neighborhood of 2-1/2%.
Long-term interest rates are essentially the sum of the real cost of borrowing (and return to saving), and an adjustment for expected inflation. No change in long-term interest rates plus no change in expected inflation equals no change in the real interest rate -- just what you would expect with a lot of global saving and not much investment demand.
Higher short-term interest rates may indeed be the response required to keep inflationary pressures in check. But that, in the long-run, will mainly impact the inflation premia required of borrowers by lenders. It is certainly possible that an overly restrictive will temporarily drive up real interest rates. But that strikes me as policy mistake, not a prescription.