Real Yield Curve

Mike Smitka

I look at data of various sorts, often out of mere curiosity. One ongoing puzzle is the evolution of interest rates. I've posted graphs of nominal rates, and implied future rates. Below are similar graphs for real rates, as calculated by Treasury using inflation-adjusted bond (TIPS) yields. The first are the real rates at various maturities. (That's the graph on the left – click to expand.) I then use the difference between yields at different maturities to calculate the implied future interest rate. (Duh, that's the graph on the right.)

At one level these look sensible. We see that longer maturities have higher yields. We see craziness in fall 2008. But real rates remain low, around 1% into the far future. They look sensible, but they don't make sense.

...[they] look sensible, but they don't make sense...

One explanation might be global excess savings, what Ben Bernanke termed in 2005 as a global savings glut, driven by countries where individuals and firms are building up financial assets as their populations grow but where they've run out of sensible domestic investment possibilities. That requires financial outflows (and for that to happen, a trade surplus). And on the US end we do indeed see the flip side of trade deficits and net financial inflows. (Again, you can't have one without the other.)

After all, conceptually the return on investment ought to be higher in labor-abundant, poor economies. But I find it hard to believe that story, when we find it going on year after year. OK, many economies have unstable politics, which might make would-be investors cautious. So savings could pile up. But we don't see sharp breaks that might be consistent with that story, that is, with the ebb and flow of politics. Indeed, if that sort of uncertainty is key, we ought to see a huge Trump bump, because politics in the US now looks zany. Policy change is precluded by political infighting and the failure to appoint staff across the Federal government. We have no ability to address a crisis, much less attend to long-run challenges such as putting in place a true healthcare system, improving eduction or setting our fiscal house in order. The bottom line is that I don't see any such effect in the data.

The other story is secular stagnation: that despite the hype and self-promotion of Silicon Valley and the venture capital vultures who circle in search of easy feeds, there just isn't much happening. Cheaper taxi services – Uber, for example – just aren't working out. And from an economy-wide perspective it's hard to see an economic revolution in that, or better dating apps, or in receiving streams of 140 characters. In the $20 trillion dollar US economy, there's room for a lot of successful new $50 million businesses, but again, from a $20 trillion dollar perspective they are chump change. Robots? – I've been visiting factories for decades, automation is already widespread. The low-hanging fruit has been picked, and "hard" goods are only a 20% slice of our consumption. Artificial intelligence? The Executive Director of our small local United Way of Rockbridge worked in the earliest AI initiative at Stanford in the 1970s. Algorithms aren't new, and the cost of computing has long been near zero. Again, the low-hanging fruit has already been picked.

...the other story is secular stagnation...

My preferred explanation then is that (to borrow the title of Marc Levinson's most recent book), the transport, information and energy revolutions that exploded after 1800 represented An Extraordinary Time. That era has now come to a close, and henceforth we will no longer see the productivity growth that underlay the rise of the US. To borrow again, this time from Robert Gordon, this represents the Rise and Fall of American Growth.

However it's not just an American story, something emphasized more by Levinson than by Gordon. It's the story throughout the OECD economies, Europe and Japan and now even China. We can pray that in the next 3 decades South Asia and Africa converge on the developed economies through their own growth miracles. But for now they're too small, and too isolated financially, to offer a solution to the secular stagnation that we see in the US.

Disclosure: I'm using Levinson's book this fall in my 2 sections of Econ 102, Principles of Macroeconomics. I listened to the Audible recorded book version this spring, and am now reading the hard copy one. Gordon is also available as a recorded book, but given his prolific use of data, I can't imagine consuming it without his graphs in front of me – and I do my listening while driving.
For completeness, Bernanke reviewed his original savings glut story 10 years later, in a 2015 Brookings post. Here too is The Demise of U.S. Economic Growth, a modest-length paper that covers the stagnation themes that appear in the latter 100 or so pages of Gordon's 750+ page book.