The ECB has lowered its official interest rate several times in recent years and the rate is now at zero. In March this year, it started in addition a large sovereign bond purchase programme. German commentators have been focusing on the negative effect of ECB policy on returns on German savings. Contrary to popular belief, however, the ECB is not the main driver of the decline in interest rates. The debate also ignores the appropriate policy response to the decline in interest rates.
Nominal interest rates have been falling for 30 years now. While in 1980, the US governments’ borrowing costs on a 10 year horizon amounted to around 13%, they declined to 8% in 1990, 5% in 2000 and to only 1.9% in April 2015. A similar picture emerges for Germany, where yields for the same type of bond falling from around 9% in 1980, to 5% in 2000 and now to 0.1%.
So what is behind this dramatic fall in interest rates, observed over the past 3 decades? Two factors are central: firstly the fall in inflation, and secondly the fall in real returns. Turning to the former, inflation rates in the 1980s were at about 3% in Germany; for the 2000s at 1.6% and currently the inflation forecast for the next 10 years is at 1.4% for the euro area. A similar picture emerges for the US.
A large part of the fall in interest rates is thus due to falling inflation rates. This is a success of better monetary policy management. Falling inflation rates do not reduce the return to savers. In fact, what matters for savers is the so-called real interest rate. Put differently, as a saver, I am interested in how many goods I can buy from the interest I receive from my savings, and this is measured by the real interest rate.
How have real interest rates developed? In both the US and Germany, real interest rates have fallen from levels of about 4% to levels closer to 1% (see graph). With the recent economic upturn, real rates seem to have increased again.
Graph: ex-post real rates (US and DE).
Source: ThomsonReuters Datastream
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