Long Term Real Interest Rates Fell Below Zero in all Euro Area Countries

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Yves here. The enthusiasm for negative real (and in some instances, nominal) interest will grate on the ears of most readers, and from what we understand, Fed officials. Contacts with insider connections tell us that Fed staffers have recognized for some time that sustained super low interest rates and QE painted the central bank in a corner from which it is having difficulty extricating itself. If nothing else, the famed 2014 “taper tantrum” was a wake up call. Financial commentators have even pointed out that US officials are not happy with the ECB being still very much a believer in the super-low rate regime that they are trying to exit.

Similarly, more and more mainstream economists have been writing that policymakers have been over-relying on monetary policy, when it is unproductive or even counterproductive (increasing interest rates will slow economic activity, but cutting them does more for asset values and financial speculation, and for businesses that depend very heavily on borrowing like real estate, than it does for most real economy activity).

But in the Eurozone, Germany is unwilling to allow Eurozone or EU level fiscal spending or stealth ways to get there, like Eurobonds or Yanis Varoufakis’ and Jamie Galbraith’s proposed EU infrastructure bank. So EU states are hamstrung by Maastrict budget rules and for most of them, not being currency issuers. And if the only tool you have is a hammer, every problem looks like a nail.

By Zsolt Darvas, a Senior Fellow at Bruegel and also a Senior Research Fellow at the Corvinus University of Budapest. Previously he was the Research Advisor of the Argenta Financial Research Group in Budapest and also served as the Deputy Head of research unit of the Central Bank of Hungary. Originally published at Bruegel

The 10-year real government bond yield, which is the nominal yield deflated by expected inflation, has fallen below zero in Italy and Greece, boosted by increased market confidence for their new governments. Romania is the only remaining EU country with a positive real interest rate. Negative real interest rates vastly help fiscal sustainability and provide a great opportunity to invest in much needed infrastructure and the transition to a carbon-neutral economy.

While nominal interest rates of all euro-area countries converged to the German rates during the first decade of the euro, large differences developed with the emergence of the euro crisis after 2009: interest rates in southern European countries and Ireland increased significantly in 2010-2013, while the rate in Germany and other top-rated countries decreased. The differences in nominal interest rates were translated to even larger differences in real interest rates, that it, nominal rates adjusted by expected inflation. Expected inflation in Germany was (and still is) higher than in southern Europe, thereby driving a large gap in real interest rates.

Low real interest rates greatly help borrowers, including the public sector, and might also boost investment and growth. At the same time, they are bad for savers. Conversely, high real government bond yields could undermine fiscal sustainability and pull private sector interest rates up, making corporate and household borrowing more costly, which weakens economic recovery. Therefore, divergent interest rate developments in the euro area is a concern and it could also undermine the transmission of ECB’s monetary policy.

The good news is that the interest rate divergence narrowed significantly in recent months. In this post I calculate the 10-year real government bond yields for 27 EU countries in comparison with Japan and the United States. I found that the real rates have fallen below zero in every euro-area country, and with the exception of Romania, in all EU countries too.

>How To Measure the Long-Term Real Interest Rate?

An important question is how to measure inflationary expectations 10 years ahead? Some analysts use the actual inflation rate, such as the inflation from last year to the current year, and deduct this from the nominal interest rate. But such a simplistic assumption is inadequate, because inflation in a particular year could be affected by unusual developments, like large swings in energy prices, which might not be expected in the future. Market-based inflationary expectations, such as inflation indexed bond yields and swaps, are useful indicators, but these are available only for a few countries. There are surveys of long-term inflationary expectations, but those are sporadic and available only for a few countries.

I have therefore decided to use inflation forecasts from the IMF World Economic Outlook, which are available five years ahead starting from the forecast made in April 2008 (before 2008, the IMF published forecasts only two years ahead). I assume that the inflation forecast for the fifth year ahead will prevail in the subsequent five years too, and thereby I calculate inflation projections ten years ahead.

Certainly, IMF forecasts (as well as all other forecasts) are subject to large errors. But this is not an issue from perspective of calculating real interest rates, because economic decisions depend on expectations. For example, ten-year forward-looking economic decisions made in 2019 depend on expected inflation in 2019-2029 and cannot depend on actual inflation in 2019-2029 (because that will be known only in 2029). If IMF forecasts represent expectations, then such forecasts are useful in calculating real interest rates, even if actual inflation in 2019-2029 will be different from the forecast.

IMF forecasts are typically published in April and October of each year, but I would like to calculate real interest rates for each month. I have therefore linearly interpolated the April and October ten-year ahead inflation forecasts. In most years this is probably a harmless assumption, given that long-term inflation forecasts hardly change from one forecasting round to the next. The exception was 2009, when the global financial crisis induced some larger swings even in long-term inflation forecasts.

Euro-Area Long-Term Real Interest Rates

The first euro-area country that faced a negative ten-year real interest rate on newly issued government bonds was (unsurprisingly) Germany in September 2011 (see the charts below). By January 2015, thirteen eurozone countries joined this club – the exceptions were Cyprus, Greece, Italy, Portugal and Spain. (Estonia is not considered due to the lack of ten-year government bond yield data, resulting from the very low level of public debt).

Real interest rates continued to fall throughout the euro-area recent years, with the German ten-year real rate falling to a stunning value of -2.7% per year in September 2019. There are nine other euro-area countries with a real rate at or below -2%. Spain joined the distinctive club of countries with negative ten-year government bond yield in July 2016, Cyprus in March 2019, Portugal in May of the same year, Italy in August and Greece in September. In the latter two countries, positive market assessment of the new governments played a major role in recent interest rate falls.

While low negative rates are great news for government treasuries*, they are bad news for government bond investors. For example, the -2.7% German ten-year real yield means that if someone invest her/his saving into a ten-year German government bond, the real value of that saving is expected to decline by 2.7% in each year. By the end of the tenth year, the real value of the saving falls by almost a quarter, that is, a quarter less goods and services can be purchased in ten years from the result of the saving than the amount of goods and services the same saving could purchase now.

The opposite effect applies to the government. The government can decide to borrow now at a -2.7 annual rate for 10 years, spend the proceeds of the borrowing now, and repay this loan from taxes collected in 10 years’ time. Or it can decide not to borrow now, but collect the taxes in 10 years’ time and spend the money then. The tax burden is exactly the same in both cases, but in the first case the government can purchase a quarter more goods and services now than in the second case in 10-years’ time. Clearly, unless there are concerns about fiscal sustainability, it is high time for the government to borrow and invest in the future – see my concluding thoughts on this issue at the end of my post.

The recent falls in long-term interest rates are most likely driven by a change in market interest rate expectations, whereby monetary tightening is not expected in the foreseeable future. In Figure 2 I reproduced and updated the shocking chart from a report by Grégory Claeys, Maria Demertzis and Francesco Papadia, which shows how market expectations of the short-term euro interest rate changed from mid-April to mid-August 2019, that is, a month before the 12 September monetary policy meeting of the ECB Governing Council. We updated the chart with early October data. While in April markets expected that the short-term euro rate will remain negative till 2025 and by 2030 it will be somewhat over 1%, the August expectations foresaw a negative rate till 2030, a major fall in expectations just over four months. There was only a slight correction from August to October. Moreover, the expected rate for 2049 was reduced from 1.17% in April to -0.1% by August, which just moved up slightly by October (to +0.1%).

The reasons for this huge shift in expectations (even for 2049) during the four months between April and August is unknown; I have some doubts whether the worsening of the near-term global outlook would justify such a big fall in expected interest rates in 30 years’ time. The fall in inflation expectations cannot explain either, because the market-based inflationary expectations of the euro area over the next ten years have fallen just by 0.25 percentage points from 1.23% in April to 0.98% in September, which is much smaller than the fall in the expected average short-term interest rate over the next ten years. For interest rate expectations further ahead, such as for 2049, not the average inflation over the next years, but the long-term inflationary expectations matter: the expected annual euro-area inflation in ten years’ time fell even less from 1.40% in April to 1.34% in September suggesting that the fall in expected short-term interest rates in the decades to come almost entirely reflects an expected fall in the real interest rate too.

Yet whatever the reason, if markets have substantially lowered their expectation for short-term interest rate in the next three decades, it is not surprising that 10-year government bond yields also fall further. Such changes in interest rate expectations, combined with the expected decline of the stock of government bonds as a share of GDP, induced investors to accept even lower negative yields on government bonds.

Therefore, in my view the change in interest rate expectations, and not the September monetary stimulus of the ECB, have led to a further fall in government bond yields. In any case the announced resuming of asset purchases from November at €20 billion per month is just one-fourth of the amount purchased in 2016. Yet real interest rates fell to much lower values now than in 2016.

Non-Euro Area Countries

The large fall in real interest rates extended to non-euro area countries too. Denmark, a country that pegs its currency to the euro, has the second lowest ten-year real interest rates in the EU at -2.4% in September. Sweden is not far with a rate of -2.1%, nor Bulgaria with a -1.9% rate. The UK’s real rate at -1.4% in September 2019 is also quite low. There were also large real interest rate falls in the four central European countries with a floating exchange rates, the Czech Republic, Hungary, Poland and Romania, leading to negative ten-year government bond yields, with the sole exception of Romania.

Interestingly, Japan, a country that’s had low interest rates for more than two decades now, has a real long-term rate of -1.5%, which is just in the middle of the range of EU countries. 16 EU countries have an even lower rate.

In the US, the real rate increased from negative values in 2016 to about 1% in 2018, due to the monetary tightening of the Federal Reserve, but more recently it fell to -0.5% by September 2019. There are only three EU countries (Romania, Poland and Greece) that have a larger rate. The ‘exorbitant privilege’ arising from the central role of the US dollar in the international monetary system has not prevented 24 EU countries (or 25, if Estonia could be considered too) from having a lower real interest rate on ten-year government bonds than the US, even in some small countries whose currency has practically no international role, like Bulgaria, Croatia, Czech Republic and Hungary.

Policy Implications

The negative real government bond yields, which are well below the expected real economic growth rates, create a lot of additional fiscal space, as it was prominently highlighted by Olivier Blanchard.

The fiscal space created by low interest rates should be used wisely. In our memo to the new EU commissioner for economic affairs, jointly written with Thomas Wieser and Stavros Zenios, we recommended channelling the interest savings to investments, such as the transition to a carbon-neutral economy, rail and road, research and development, and digital infrastructure. There are pressing public investment needs in many countries and the negative real interest rate environment presents the perfect opportunity to finance such needs. Moreover, in the current environment of deteriorating economic outlook and low inflation, at a time when the European Central Bank has limited scope for additional monetary easing, a temporary discretionary fiscal boost is the right policy answer.

However, while real government bond yields fell everywhere, differentiation is necessary because the highly-indebted countries should not repeat past mistakes of pretending that they can spend their way out of the debt sustainability trap.

And policymakers should recognise the risks of a possible medium-term reversal of interest-rate developments, which has two main implications. First, additional spending should focus on categories that are easier to reverse, e.g. it is easier to reverse an investment stimulus than increased entitlements. Second, governments should ‘lock-in’ as much low interest rate debt as possible, for example by rolling over maturing short-term debt with long-term debt.

Endnote:

* I emphasise that I consider the real rate on new borrowing, while government bonds issued earlier have their own –typically larger– interest rates to pay. But the longer the period of negative rates lasts, the lower the total interest burden becomes.

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20 comments

  1. Rob Chametzky

    Yves wrote: “And if the only tool you have is a hammer, every problem looks like a nail.”

    This is, I think, more another instance of the related principle I have characterized thusly:

    “If all you have is a hammer, everything looks like a thumb.” (Chametzky 2011: 324)

    –Rob Chametzky

    Reply
  2. Susan the other`

    Negative interest rates in lieu of the wholesale bankruptcy of the western economy? I have trouble following this analysis because it slips and slides through the dangers of inflation without seeming to ever define inflation – something all “economists” omit. If inflation is the biggest risk to a stable economy why can’t it be clearly defined? I think the idea of inflation is all mixed up with that barbaric relic, gold. As is the idea of a strong currency. Ironic then that the economic depression allows the euro rate to logically go negative, causing our Fed to agonize, rightly, about the stability of the Free Market at NIRP. Funny thought. Clearly we have the wrong inflation model. (whatever it is – and it can be whatever we want it to be…) It is easier for the ECB to go NIRP forever because Europe has a good social safety net, even though it is being eroded. Whereas here in the US it is sink or swim until you are 65 and then it ain’t easy. The scaffold of our economy is the essence of neoliberal economics and if anyone breaks away the whole thing begins to slump. That’s one reason why negative interest rates are a giveaway to the rich – it is the poor who save who need a better return on their money just to get by. To help pay for some of the things the state pays for in Europe. Health care, long term unemployment, public transportation, etc. We are being systematically drained to prevent the sort of “inflation” that would harm the neoliberal elite. Where Germany is free to borrow all it needs to do overdue infrastructure projects and is doing so, we here are hamstrung by the entire concept of good fiscal spending – we don’t understand it at all. Because our entire system depends on us not understanding it.

    Reply
    1. notabanktoadie

      That’s one reason why negative interest rates are a giveaway to the rich … Susan the other`

      There’s good ways to lower interest rates and bad ones.

      Some bad ones:
      1) Limiting fiat use to depository institutions.
      2) Central Bank buying from the private sector.
      3) Central Bank lending to the private sector.

      Some good ones:
      1) negative interest on large and non-individual citizen accounts at the Central Bank.
      2) an equal Citizen’s Dividend financed in part, at least, by 1).

      Reply
      1. deplorado

        Thank you for this (I’ve even saved other comments of yours on this topic as I find them a perfect distillation of what, let’s call it, banking and fiat for the people could be).

        I see public banking initiatives gaining traction in NY state and California, but their scope is much more limited – perhaps recognizing the difficulty of pushing such changes that benefit the plebs. Do you perhaps know of initiatives or organizations that you can point us to working to bring, for example, citizen’s accounts at the Fed? Or any serious body of work, academic or otherwise, that one can use to educate themselves and others on how fiat for the people would work?

        Reply
        1. notabanktoadie

          I see public banking initiatives gaining traction in NY state and California, but their scope is much more limited – perhaps recognizing the difficulty of pushing such changes that benefit the plebs.

          Monetary reform should be ethically unimpeachable and public banking does not pass that test since it would extend the public’s credit but for private gain, i.e. government should not be in the lending business. Otoh, it’s perfectly natural and a near (if not an absolute) ethical necessity that government provide debit/checking accounts in its fiat to all citizens AND that all fiat creation should be for the general welfare – and that would include an equal Citizen’s Dividend beyond the fiat created by deficit spending.

          Do you perhaps know of initiatives or organizations that you can point us to working to bring, for example, citizen’s accounts at the Fed?

          Sorry, no. Not that I’ve looked lately, having become discouraged by one flawed approach or another.

          Or any serious body of work, academic or otherwise, that one can use to educate themselves and others on how fiat for the people would work?

          None that I can fully endorse (not that they might not exist) but if you google “central bank accounts for all”, you’ll see the idea has certainly been broached – including by central bankers (or staff) themselves.

          Reply
          1. deplorado

            Thank you.

            I think particularly this bit – “all fiat creation should be for the general welfare” – should be in the constitution.

            Reply
    2. Futility

      Where Germany is free to borrow all it needs to do overdue infrastructure projects and is doing so, we here are hamstrung by the entire concept of good fiscal spending – we don’t understand it at all. Because our entire system depends on us not understanding it

      Except we don’t (Germany). The German political class is entirely enthralled by the concept of ‘the black zero’. It even entered the ‘Grundgesetz’. New borrowing is avoided like the plague. A new just released study places Germany at the lower end within EU countries regarding internet connectivity (especially in rural areas), the new climate package proposed by the government is overly timid lest the state has to take on more debt, public infrastructure in the west of Germany has its good days behind it, research and development could be better funded, public housing was sold to investors for a pittance (“The state has no business being in real estate!”) and now as rising rents are prizing out the lower classes from the cities they work in, public housing has to be bought back at a premium. The neoliberal doctrine has infected all minds and instead of using the additional wiggle room, the elites are starting at the black zero like deer into the head lights.

      Reply
      1. Susan the other`

        So Germany will be paying as they go with taxes? But still they (you all) have taken the initiative to do fiscal spending in a timely manner. With economies going into recession everywhere, now really is the time to take some action.

        Reply
  3. p, fitzsimon

    As of this morning the rate on the 10yr treasury is 1.58%. With inflation for the preceding 12 months at 1.6% doesn’t that give us negative interest.

    Reply
  4. JEHR

    It appears as though we all will eventually pay and pay and pay for the bail out of the banks in 2009 and onward for a long period of time. Now is the time to increase tax rates for everyone who is in the top 10% and increase wages and salaries for everyone else.

    Reply
  5. notabanktoadie

    But in the Eurozone, Germany is unwilling to allow Eurozone or EU level fiscal spending or stealth ways to get there, like Eurobonds or Yanis Varoufakis’ and Jamie Galbraith’s proposed EU infrastructure bank. Yves

    Otoh, should even Germany oppose an equal Citizen’s Dividend (CD) to all Eurozone citizens – including Germans? Whose stated purpose is merely to counter price deflation or provide a small amount of price inflation? And whose amount varies as needed?

    And if (or regardless if) the Germans are opposed to Overt Monetary Finance then let the CD be funded with negative interest on large and non-individual* citizen accounts at the ECB.

    *Presupposing that Euro zone citizens are finally allowed to use Euros in account form via accounts at the ECB.

    Reply
  6. OpenThePodBayDoorsHAL

    So riddle me this: the supposed purpose of a central bank is to provide stability to the banking system. Which is composed of: banks. And just in the past week the CEOs of the biggest banks in Europe – UBS, Deutsche, and Credit Suisse – have all savaged the very concept of negative interest rates. Words used: “absurd; destroy; disaster; destruction”. So what in the hell?

    The Fed has injected almost a cool half trillion into the system in the last 3 weeks (repo) without daring to call it QE. Now today Powell is jawboning “NOT QE4” resumed asset purchases.

    So as a matter of national and global emergency I say we have no choice but to begin immediate impeachment proceedings against: Powell; LaGarde; Kuroda. These suicide bankers must be stopped.

    Rabobank quotes a few paragraphs that lay bare where we are. The proper word is: DEFAULT:

    Banks create debt (and hence broad money-supply) via lending. If that lending goes to productive investment the stock of money and goods are matched and there is no inflation and there is no long-term increase in debt to GDP. If the productivity growth from the new enterprise is fairly split between profits (for further investment) and wages (for consumption) then the growth cycle continues without a long-term increase in debt to GDP.

    However, if businesses push down wages for profit–via globalisation–then consumption growth can only be sustained by borrowing, and debt to GDP trends up: when it hits a peak, growth permanently slows. At that point, businesses have no need to borrow – or if they do it is to speculate on financial assets and not invest in productive business. Growth slows further, and the cycle breaks down structurally. Governments have to then invest more and/or force wages higher. [YOU ARE HERE].

    Central banks lowering rates merely sees housing and/or equity bubbles running on fumes. Each hiking cycle is replaced by an easing where we see lower highs and lower lows until we go negative – which is de facto debt default. And/or we do QE, which the Bank for International Settlement recently agreed does not flow to the real economy, but pours more liquidity into asset markets, making the rich richer. Unless QE allows governments more room for fiscal spending – which is de facto debt default. [YOU ARE HERE]

    Reply
    1. notabanktoadie

      If the productivity growth from the new enterprise is fairly split between profits (for further investment) and wages (for consumption) then the growth cycle continues without a long-term increase in debt to GDP. [bold added]

      So how will that work when automation has eliminated say, 80%, of all jobs?

      Who’ll do the consuming?

      Reply
    2. notabanktoadie

      Unless QE allows governments more room for fiscal spending – which is de facto debt default [bold added]

      How? Lower interest rates on new debt mean HIGHER prices for existing debt. That’s not default, that’s a bonus.

      Reply
    3. deplorado

      I’ve seen views interpreting these bizarre policies as serving the ECB’s goal is to destroy the small regional German banks and similar banks across the Eurozone, in order to bring down national bank systems to ruin and bring those countries one step closer to a United States of Europe.

      Interesting view.

      Reply
    4. notabanktoadie

      So riddle me this: the supposed purpose of a central bank is to provide stability to the banking system. Which is composed of: banks. OpenThePodBayDoorsHAL

      And why should the rest of us even care about the stability of banks anymore than we care about gamblers in Las Vegas?

      Hence the need for TWO payment systems:
      1) the current one, for at-risk deposits, that works through depository institutions
      AND
      2) an additional, risk-free, payment system consisting of debit/checking at the Central Bank itself for anyone who wants one but for FREE only for individual citizens up to a reasonable account limit.

      Shouldn’t we be tired of being hostages to government-privileged usury cartels?

      Reply
  7. chuck roast

    My wife likes to say that the widespread ownership and mis-use of guns is a healthcare issue, both mentally and physically. I like to say that ultra-low interest rates – otherwise known as free money – is an urban health issue, both mentally and physically.
    In the last 10 years the two mid-sized New England towns that I am most familiar with have literally metastasized. Free money and relatively low taxes have permitted, nay encouraged, the near-rich to travel widely and stay in the the hotels that are appearing like mushrooms where ever there is an empty urban space. New corrugated-clad “luxury condos” pop-up in the spaces that are left, and the mindless planning mantra “highest and best use” permits the clearing of structures that were “economically marginal,” that is, used by the poor and working class. What were formerly culturally rich and diverse cities become bourgeois, designer-dog, theme parks. And it all passes under the rubric “economic growth.”

    Any urban space left over is quickly filled by a branch of Generic Savings & Loan. And why not? If banks can create their very own money, why shouldn’t they use for their own viral purposes.

    So, now the Danes are offering “negative interest rate mortgages.” What does that mean? I can’t wrap my head around it It sounds like MRSA. Some new, alien bacteria that is sure to undue what is left of our mental and physical health. One thing we can be sure of is that those of us without a large bank account with a wonderful 1.2% return will again be well and truly screwed.

    Reply
  8. Christopher Herbert

    Not for nothing but taxes and spending make interest rates irrelevant in terms of economic health in a monetary sovereign nation. Too much savings, tax it away. Worried about international global speculation, put in capital controls. Replace demand created by deflationary policy decisions, like medicare for all which would be deflationary, by building out community medical centers. Spend into sectors which need liquidity and productive investment, tax away wealth that is being spent on wasteful, or unnecessary, sectors. Screwing around with interest rates is a weak reed at best.

    Reply
  9. cnchal

    Words have lost their meaning. Any entity that invests to lose isn’t investing and with negative interest rates the only apparent reason to touch this load of crap is to cash out to an even greater idiot if interest rates go even lower.

    If interest rates go up, even a little, there will likely be a panic to unload this crap with the idiots nowhere to be found.

    I now know what happened to productivity and why it is not getting better. Too much money is being paid to eclownomists for nothing of value in return. Lets cut the losses and fire them all.

    Reply
  10. notabanktoadie

    Any entity that invests to lose isn’t investing and with negative interest rates the only apparent reason to touch this load of crap is to cash out to an even greater idiot if interest rates go even lower.

    While individual citizens should be shielded from negative interest up to a reasonable account limit, why should non-individual-citizens and large fiat (or other inherently risk-free sovereign debt) accounts get to use a public utility for free or worse be paid to do so?

    Besides, risk-free collateral is useful even at negative yields.

    Reply

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