Interest rates will increase eventually in developed part of world, more likely at start of 2015. Markets are now braced for such possibilities but here’s the difficult part, how much they will rise, what will the normal interest rates in post crisis world? What will be rate expectations and emerging markets performance during crisis?
History of these events
In 50′s and 60′s, real rates used to be lower as capital control kept the investors moving their money to find high returns. For this the government held down rates In order to reduce their debt burdens. This tactic is known as financial repression. In late 70′s the sudden surge in the inflation got investors all of sudden which pushed the real rates down. Years later, the bond vigilantes reacted in 80′s by making the bonds yield higher. But as inflation declined, the real rates increased instantly. At last, it saved the glut of early 2000′s which was followed by 2008 crisis leaving the rates to be plunged once more.
Importance of economic growth
Rate of economic growth is important in respect to the gloomy people however, the trend of growth has dropped more than 10% around the world. The demographic trends mean workforce will be reduced which leaves productivity to do all chores for expanding economy. As other things are now equal, slower growth means low interest rate.
But what about other things, will they be equal? The ageing population suggests that elderly will now draw their savings for retirement. The real rates in Japan have been positive in the recent years, well the credit goes to deflation in addition of moribund economy. Apart from that, investors are saying debt burden is so great that I can even lead to inflation and therefore demands high rate in order to compensate the risk.
Role of globalization
Another fact is globalization. The emerging markets are expanding faster even compared to developed work and this will attract investors hungry for high returns. Speaking rhetorically, this will increase rate expectations and emerging markets performance during crisis. But the truth is real rate will be held by financial repression, insurance companies and even pension funds. The companies will force the real rate by their regulations for getting their hands on more bonds whereas Central Bank have brought in big amounts of debt from government and till now there are no signs of selling it.
On contemporary, the neutral rates might be lower than the market expects. PIMCO, fund management group suggests neural rates to be closed near zero. Therefore 2-4% nominal terms if inflation targets are met by 3%.
A sign of relief
Before home and small owners could relax, this discussion has touched the concern of Neutral Rates. Rates will be increased if central reins back the economy, mainly because of better returns. It is now being said that this is perhaps the miracle of perfect monetary way out. This would need financial stimulus to be withdrawn before economy recovers and not after. As it comes to central backs, the economic forecast is awfully correct.
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