Historical trends suggest higher real rates ahead
As central banks reduce rates, many wonder where rates will stabilise.
While real interest rates have trended down for decades, Westpac chief economist Luci Ellis (pictured above) argued that rates could remain higher post-pandemic than during the pre-pandemic era.
“Real rates have trended down for decades, but a very long-term view supports our thesis that rates will average higher in future than they did pre-pandemic,” Ellis said.
Fiscal pressures point to higher rates
Global economic demands like defense, energy transitions, and aging populations are pushing governments to spend more. This increase in demand for investment, alongside Western banking systems’ greater flexibility, is likely to lead to higher average interest rates.
“Western governments are facing greater demands to spend on defense, energy transition, and meeting the needs of an aging population,” Ellis said.
A long-term look at interest rates
Recent research by Kenneth Rogoff, Barbara Rossi, and Paul Schmelzing examined real long-term bond yields spanning over 700 years.
Their findings suggest a historical downward trend in real rates, but the period between the Global Financial Crisis (GFC) and the pandemic deviated from this long-term pattern.
The data points toward a potential return to this trend, indicating that lower rates seen during that period may not be permanent.
Lessons from history: Rates and longevity
Ellis also drew connections between historical events like the Black Death and long-term interest rate trends. She suggested that rising longevity could explain the downward trend in long-term rates.
“Rising longevity, or greater certainty about adult longevity, could be one of the reasons people have become more patient and willing to accept lower compensation for waiting,” Ellis said.
Implications for policy and planning
For those in financial markets or fiscal policy planning, assuming that the ultra-low rates of the GFC-to-pandemic period will persist could be a mistake.
“It would be foolhardy to assume that the low-rates world of the GFC-to-pandemic period will continue,” Ellis said.
The evolving global landscape suggests a future with higher real rates on average, Westpac reported.
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