Real interest rates

It is a while since I’ve done a real interest rate post, so here goes.

You’ll see stories from time to time about how low the New Zealand government’s borrowing costs are.

But it is still worth reminding ourselves of New Zealand’s long track record of having among the very highest average real interest rates in the advanced world.   Here, for example, are New Zealand, Australia, and the G7 countries for the last five years (the period chosen a bit arbitrarily, but a different set of dates wouldn’t substantially alter the relative picture).  I’ve just used average bond yields and average CPI inflation, from the OECD databases, but using (say) core inflation also wouldn’t materially alter the picture.

bond yields

Among these countries, we have one crisis-ridden hugely indebted euro-area country (Italy), one country with new substantial political and economic uncertainty –  and quite a lot of debt (the UK), one with extremely high levels of public debt (Japan), and one with recklessly large fiscal deficits and rising debt (the US).  And our real long-term government bond rates have been higher than all of them.

If we look at the situation today, the picture isn’t a lot different.  Italy has gone shooting past us, which should be no consolation to anyone (crisis pressures re-emerging there).  The gap between New Zealand and US real interest rates has narrowed quite a bit, as one might expect from the sequence of Fed interest rate increases in turn driven partly by unsustainable late-cycle fiscal expansion, but a 10 year US government inflation indexed bond was trading this week at 1.04 per cent, and a 10 year NZ government inflation indexed bond is trading at about 1.25 per cent.   Even that gap is substantially larger for 20 year indexed bonds.

As a reminder, our interest rates don’t average higher than those abroad because of:

  • superior productivity growth rates (we’ve had almost none in recent years),
  • macroeconomic instability (we have low stable inflation and low stable public debt),
  • public sector credit risk (see above –  and of the countries in the chart only Australia has comparably strong public finances),
  • weak banking systems (the Australian banks and their NZ subs have some of better bank credit ratings in the world),
  • risk around high levels of external indebtedness (not only is much of the external indebtedness on bank balance sheets –  see above –  but the New Zealand exchange rate has been persistently strong, not a feature you expect to see when risk concerns are to the fore).

Oh, and of the small OECD countries with floating exchange rates, over the last five years only Iceland (recently emerged from serious systemic crisis) and Hungary (IMF bailout programme as recently as 2008) had higher real interest rates than New Zealand.

At the heart of any explanation for this persistent real interest rate gap –  which has been there, on average, for decades –  must relate to factors influencing pressure on resources in New Zealand.   At some hypothetical world interest rate, there is  some mix of more demand for investment (housing, business, government) and a small supply of savings (households, business, government) than in most other OECD countries.    That incipient excess demand on resources is absorbed by having a higher domestic interest rate than in most other countries, and a higher real exchange rate.    That mix of adjustment will then squeeze out some of the incipient excess demand.  Global evidence suggests that overall savings rates aren’t very sensitive to changes in expected real returns.  Governments tend not to be very responsive to price signals, and people have to live somewhere (so although residential investment is highly cyclical, in the end everyone gets a roof over their head).  Much of the adjustment pressure is felt around genuinely discretionary, and market sensitive, investment spending: business investment, and especially that in sectors exposed to international competition.   It is the stylised story of New Zealand: moderate savings rates (overall), quite high rates of government and residential investment, modest rates of business investment, and a tradables sector which has managed little per capita growth for decades, and where international trade shares of GDP are stagnant or falling even a period when world trade blossomed.

And that is where my immigration policy story fits in.   Savings and investment pressures are aggregates of all sorts of forces and preferences, and so one can never say that a single factor “explains” the whole picture.  But if one is looking for areas where government policy – a non-market or exogenous influence –  plays a part, then New Zealand immigration policy over decades seems likely to be a significant part of the story.  Lots more people means lots more demand for investment just to maintain existing capital/output ratios.   New people need houses, and schools and roads and so on.  If this were a country where domestic savings (flow rates) were abundant –  and domestic savings are different from foreign savings because the act of saving domestically takes some pressure off domestic resources (incomes generated here not spent here) – it wouldn’t be a particular issue.  But that isn’t so in New Zealand.  Government policy choices may have influenced those outcomes to some extent –  I certainly favour a different tax treatment of savings –  but my reading of the international evidence leaves me sceptical that reforms in that area would make very much difference to desired savings rates (if only because income and substitution efforts tend to offset).

Instead, conscious and deliberate government policy drives up ex ante investment demand (at the world interest rate), and in the process tends to drive out the sort of investment that might have enabled those of already here to achieve better material standards of living.

(In a very small sample, it is perhaps worth noting that there are four OECD countries where policy is set to favour high rates of immigration.  They are New Zealand, Australia, Canada and Israel.  It should at least prompt a moment’s reflection among the immigration champions, that not one of those countries has been a stellar OECD productivity performer –  Australia and Canada have done better than New Zealand and Israel, but are nowhere near the OECD frontier, despite the abundance of fixed natural resources those two countries have.)

25 thoughts on “Real interest rates

  1. Nominal interest rates are always higher because of monetary policy, which is controlled by one unelected man, and when combined with aggressive anti-union policies (and tax cuts) by the National Party the result was re-distribution of income to the 1%. People like John Key. Remember that he waved Zimbabwean bank notes at the dreadful Green co-leader who dared mention Q.E. Most of the countries you mentioned did use Q.E. but the zealots were still in charge of monetary policy here. Until Orr came along…

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    • Can’t agree. The RB Governor sets the nominal short-term interest rate, but these are real long-term interest rates. And even tho over the last 7 or 8 years, inflation here has undershot target (as it has in most of these countries) over a 30 year view (the life of the current Act) the Bank has on average had inflation about target (too high in the first 20 years, and too low since then).

      And as of now – with new Governor – real interest rates here are still substantially higher than in most advanced countries. Monetary policy isn’t the answer to this particular conundrum (on average over long runs of time). Over long periods, the Governor ends up setting the OCR more or less where real economic forces (savings and investment pressures) drive it.

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      • Some of us, savers (risk averse), don’t see high real rates as bad. Although I personally find rates offered by our major banks appalling: even capping my tax rate as 28% via PIEdeposits, I’m barely keeping up with my personal inflation rate (especially petrol and alcohol consumption).

        Mind, I’d hate to be an elderly saver elsewhere in the developed world, esp places like Japan where the BOJ have pretty much done away with the very concept or at least ability to save. And I wouldn’t be in share markets right now (or since end of January), so it’s bleak times for savers and speculators of asset bubbles – although the risk-averse savers worldwide have been sacrificed by central bank governors over last decade in a manner I’ve never seen and I think immoral. And I still don’t see how this system is the working of free markets.

        Interesting post, however, as always, Michael.

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      • I’m a risk-averse saver myself, and trustee of a couple of super funds, so I understand the perspective.

        I think high (even higher) real interest rates would be wonderful – almost umambiguously – if they were reflective of/consistent with really strong and consistent productivity growth.

        And they’d be dreadful if the reflected huge risk and uncertainty…

        Liked by 1 person

  2. I have trouble understanding but this seems to be the centre “”more demand for investment (housing, business, government) and a small supply of savings (households, business, government)””.
    You are right about savings not being sensitive to returns – obviously if I have money to be saved I will look for the best return but a better return never persuades me sell my car and save more and as with my modest savings in the UK that have a zero return – they are still savings for a rainy day.
    No one will dispute your assertion about “”Governments tend not to be very responsive to price signals”” although most of us would express it more bluntly.
    So you make a good point about small differences in the balance between demand and supply become magnified when it comes businesses investing for greater productivity.

    My queries are (1) what about those periods when emigration roughly balanced immigration, do they show up in the data and (2) where is the difference between the financial effects of immigrants into Auckland from abroad and immigrants from rural New Zealand who are leaving empty villages behind with derelict housing and boarded up shops?

    My hesitant proposal is that NZ immigration, despite all the talk, is predominately 3rd world waged. See the 73 out of 75 Chorus subcontractors who have been found to be exploiting workers. If I had a reasonable sized business it would always be easier to invest in docile cheap labour (note Chorus’s exploited workers didn’t complain – it took a trade union to raise the issue and make it public). At a guess in Switzerland and Norway they will have been rolling out a fibre network too but with well paid local staff and state of the art tools. If employing really cheap staff why bother with really expensive equipment? On the other hand I am confident that the small NZ business that employs my wife’s PNG stepson as one of a team of immigrant consultant electrical engineers are using the latest state of the art equipment – why pay over $100K pa and not have the best office, vehicles, computers, electrical test equipment for your staff.

    In theory highly paid immigrants could increase our national productivity – maybe worth giving it a try?

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    • On your final point, yes it is certainly easy to envisage that some very capable and innovative people migrating here could make a material (helpful) difference. then again, why would many of them choose here (rather than richer more successful free and democratic countries). I’d be happy to focus a reduced immigration target much more on a small number of very able people.

      Going back to your questions, the periods when migration is balanced, or there is a net outflow, have tended to be poorer performing periods, but it is likely that there is a common third explanation (state of the econoimc cycle) rather than that (lack) immigration is the cause. the best experiment would have been the period from about 1973 to about 1990 when we cut back immigration a long way – and we certainly got a weaker real exch rate thru that period – but so much other stuff (mostly bad) was going on in policy, esp in the early period, that it is hard to get a very clean read.

      If NZers were abandoning villages and moving to the city that would have many of the same effects (on resource pressures) as foreign migrants. As it happens tho, there has been a net outflow of NZers from Akld to the rest of the country in the last couple of decades, and in most regions the populations have been flat rather than declining sharply (ie there isn’t a lot of simply abandoned capital stock).

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      • I realised you would comment about Auckland losing natives. I suspect Hamilton and Tauranga and maybe a few other middle ranked cities are growing and with their growth from mainly Kiwi born immigrants. Certainly driving around NZ there is a move from rural to urban. Of course such moves creates a housing demand but unlike foreign immigrants they do not change the demand for vehicles, clothing, food, teachers, nurses, etc.

        I remain suspicious of high levels of immigration but not certain your argument is solid – persuasive yes, certain no (blame my lack of economic understanding). The negatives issues with what I would call importing 3rd world labour conditions I am convinced are evil consequences of bad immigration policies and I blame our govt. Fortunately I think they are very slowly coming to the same conclusion but do not know how to act without being accused of racism.

        Why would many really able people want to live in NZ? Assume one person in 10,000 is really talented; that is 1 million potential talented immigrants – you only need one in a hundred to appreciate the unique features of NZ (mainly its space) to have a healthy number of applications for immigrantion, add partners and children and our current number of partnerships and refugees and there would be roughly the same number of immigrants as today but virtually no exploitation and corruption and 10,000 new competitive innovators every year.

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  3. As always, very interesting (excuse the pun).

    A few questions:

    Aren’t the lower interest rates in Japan, Italy, UK and US due to QE? I.e. a deliberate choice not something ‘natural’ result of supply and demand for loanable funds?

    Does the BOJ effectively control long term rates in Japan via its bond buying penchant?

    At a fundamental level – does investment create savings or do increased savings create investment? Is saving merely the accounting record of investment? In which case, if we all saved 20% more and stopped buying kitchens, would investment just spontaneously occur or would the dampening of demand suppress investment?

    Does government saving (paying down debt) result in more business investment in the productive economy? I.e. does the cash paid back necessarily get invested in the real economy?

    I find investment and saving very perplexing.

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    • Your final sentence is probably a good start!

      Re QE, I’d argue that the evidence is that it hasn’t really been that important. Central banks can only lean against economic forces for so long – if Jap. interest rates were somehow “artificially” low, we’d eventually see inflation presssures breaking out, and there hasn’t been anything very evident on that score.

      On a couple of your questions, if we all suddenly chose to save a lot more then, all else equal, aggregate demand would weaken considerably, and real interest rates and the real exchange rate would fall. In response one would expect more investment (especially in the export sector), but one would also expect to see a current account surplus emerging.

      The government situation is more mixed. An increase in govt savings could have the same effect. But it could also lead us to think that because the govt is better off (less need for higher taxes in future) we can all spend more now. For various reasons, there tends to be some offset between higher (lower) government savings and lower (higher) pte savings.

      One often neglected aspects of savings is business savings. Firms that invest typically account for depreciation on the asset. The amount provided for depreciation is part of (gross) business savings. Strong business investment also tends to lead to higher gross business savings.

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      • Go on pull the other one. Central banks can set the rate on bond yields of any term indefinitely. They often choose to leave it to private markets but never do they have to.

        And seriously your rehashing the Ricardian equivalence theory. Usually when the government tends to its saving then the private sector cuts investment as private sector income is most of govt sector dissaving (the rest in the current account deficit).

        Liked by 1 person

      • Yes, as I noted too, central banks can set nominal bond yields (but not real ones). Mostly they don’t do so. and if they did they can’t do so independently on any inflation consequences. As global inflation has been quiescent it suggests bond yields haven’t been far from what overall savings/investment pressures would warrant.

        Read my comment carefully. I did not – and am not – invoking Ricardian equivalence, simply noting that correlation in the data, which can arise for various reasons (almost certainly mostly not including Ricardian effects, which I don’t believe are generally important),

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      • The Ricardian equivalence idea doesn’t seem very plausible to me. People don’t rush out and spend when the government does an austerity drive reducing the people’s savings. If you’ve lost your job as a teacher you don’t buy a new kitchen.The government is taxing more than it is spending, so by definition net private domestic savings must be going down to pay the taxes given a current account deficit. Net private savings = government deficit + current account balance. Hence why we see private savings always going up mirroring public deficits going up. I think the sectoral balance ideas explain the relationship better.

        Say the government borrowed less for infrastructure and we borrowed less for buliding housing. Wouldn’t that reduce incomes and therefore saving?

        Couldn’t an alternative story be told? General aggregate demand is too low in NZ for business to expect returns on investment and so they don’t bother? And an even lower rate might just signal even more doom for demand expectations and even less investment?

        If low interest rates stimulated lots of business investment wouldn’t we have seen a much faster recovery in it post GFC?

        I’m just not convinced that interest rates are that effective.

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      • Just on your final couple of sentences, remember that neutral interest rates themselves can change (including for reasons like demographics, changing technology etc). The standard view of the last 20 years is that those neutral rates have fallen a long way. Monetary policy potency is about what happens when you push interest rates away from the (unobserved) neutral rate, not only directly (boosting investment) but through the exchange rate channel (increasing returns to exporting and thus indirectly stimulating investment in those sectors). Empirically, the real difference is separating out all the various forces at work.

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  4. Cyber Bullying costs $444M/year

    “That finding shocked economist ,Shamubeel Eaqub who led the research.

    “I think there’s a really big, big missing piece there that we have to work really hard to make sure that people know where to get help and to ask for help,” he told the Herald.

    Eaqub said there clearly needed to be a more aggressive approach to tackling the issue.

    “Online use is prevalent across all age groups now.”
    https://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=12139665

    Wow we really should be cracking down on cyber bullying. After all that internet thing is full of off message/hate speech?

    Roll Up! Roll up! Read All About It! – False Balance.
    https://www.theworkshop.org.nz/our-people/

    False Balance is including “bad information” with “good information” (that from “very good sources” with trash).

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      • On reflection, I suspect the commenter may be getting at a suggested incongruity between Eaqub’s role in this exercise, and his attempts a few years ago to respond to my immigration/economic performance narrative by labelling me “racist” (in a hard copy newspaper rather than in something that might fall under the Harmful Digital Communications Act).

        https://croakingcassandra.com/2015/07/18/how-not-to-have-a-reasoned-and-deliberate-discussion-of-housing-and-immigration/

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      • Why I have an absolute aversion towards the likes of Eaqub (Born Bangladesh) and Makhlouf (not Born in NZ) who come to NZ and begin telling “us” how to do things and what is wrong

        When I moved to Australia my job was responsible for computer engineers in a medium-size IT company. Without thinking I often preceded conversations with “in NZ we did things this-a-way” for which I received a lot of hostile push-back. Took me 3 months to change that behaviour realising there was serious cultural opposition

        Which reminds me of this episode of the way they do open hostility

        You want verbal and racial abuse – check this out – it sparked a national discussion on the level of racism and xenophobia in Australia and it had nothing to do with skin colour
        https://www.theguardian.com/world/2012/nov/21/melbourne-racist-bus-rant-australia

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      • I think there is quite a distinction between someone like Eaqub, who came here as a child and had most/all of his education here, and someone who blows in late in life on a work permit (altho of course even he is appointed by our own govt). I disagree with much of what Eaqub says but I’m pretty sure that would true even if he’d born in NZ.

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      • Sorry although I think they are desperate to silence some points of view:

        Jess Berentson-Shaw (of The Workshop):

        “One common form of information manipulation we see is the framing of issues in values that encourage beliefs and action harmful to a co-operative society. For example, we frequently see issues framed by fear. Donald Trump does it, politicians do it, news editors do it, opinion writers do it. People frame an issue to focus us on our personal safety. In doing so they are encouraging us to prioritise our “security values”.

        When we prioritise our security values it is difficult to think about what else we value. For example, living in a tolerant society that takes care of everyone. Instead we will accept incorrect information believing it will work to protect us. When people frame an issue in security values we have no motivation to hear evidence showing we can achieve a more tolerant society.

        We dwell, for example, on the threat that “snake like” lines of immigrants in K-Mart presents. People claim very tight immigration policies will protect our jobs, houses, parking space or whatever. We believe it because at this point we value our security most. This framing is then repeated ad nauseum across media channels, workplaces, op-eds and dinner tables.

        We lose the opportunity to have a decent public conversation based on good information as the framing drowns out our ability to prioritise other values and see other evidence.”
        https://thespinoff.co.nz/society/13-08-2018/misinformation-is-riding-a-digital-wave-heres-how-we-can-counter-it/

        The argument is that only a few have the capacity to make sound judgements and without their intervention: “the pairing of manipulated information with the new tools of digital media is removing power from the public”.

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  5. …..ditto Novice – also perplexed!! e.g. if real interest rates are ultimately driven by real forces, where does that leave the influence of the flow and stock of credit/debt? including the possibility of banking weakness or public debt risk seems to mix nominal/money variables in with real variables? which seems logical given history (although, can a financial crunch occur in a S=I framework?) as credit can be extended independently of a flow in savings?? e.g leverage an income stream and/or asset; perhaps an early morning run will help clear the muddled thoughts……!!

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    • There is a distinction between cyclical and across the cycle perspectives. Clearly, real interest rates fluctuate with the cycle – itself largely about underlying S/I perspectives (booms tend to have strong investment demand etc) – and so it is more useful for many purposes to take a longer-term view. Our real int rates have been well above those in other advanced countries for decades, and as I’ve shown in previous posts there is no consistent sign of those gaps closing.

      Interest rates can end up being very high because of risk, but that is partly why I ran thru the checklist of possible risk factors in the post: none is much help in explaining the NZ experience. And thus, of course, risk can crystallise in crises, altho in a typical crisis short-term real rates (in particular) tend to fall sharply, as investment demand collapses and precautionary savings rises. Long-term rates may still rise, depending on confidence in the resolution of the situation – eg Italian yields are rising now, while US govt yields fell sharply in the 08/09 crisis (but mortgage bond yields didn’t for a long time).

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      • ….thanks; to my mind, the influence of ‘risk premiums’ seems to lurk in the background on the debate over the long run real rate? e.g. to your point, business investment – the stuff of risk taking – has been low perhaps due to relatively higher real rates but what of credit spreads/equity risk premiums? these seem equally time varying in nature with a myriad of factors impacting their level at any point in time?? a focus on defacto risk free rates seems to overlook the role of credit/capital markets in the financing of business investment…

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