Unconventional Wisdom The Old Normal :: Macquarie Research,

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Unconventional Wisdom
The Old Normal
Event
 A debate has started about the likely level of real US interest rates over the
longer term.
Impact
 It is one thing to hold down real interest rates during a crisis. It will be another
matter altogether if the Federal Reserve suppresses US real interest rates
indefinitely.
 Such an outcome is a distinct possibility. While fixed-interest investors may
not like it, a long period of low real interest rates would just mark a return to
the old normal.
 For equity markets it would be a very helpful development.

Analysis
 The complaints have started. “US real long-term interest rates are too low”.
And according to one claim if they stay too low this will amount to
confiscation. Apparently the proponents of the “new normal” don’t quite like
one of the possible implications.
 A debate has started about the appropriate level of US real interest rates once
the FOMC begins to normalise its monetary policy settings. Should the
Federal Reserve allow real long-term interest rates to rise back to the levels of
recent decades? Or will there be years of much lower real interest rates even
if nominal interest rates are higher than they are today?
 This is not just a matter for academic argument. Long-term real interest rates
are a crucial variable for business investment and setting the correct level will
be vital for the restoration of sustainable investment growth in the US.
 It is important to realise that an extended period of low real long-term interest
rates would not be unprecedented. With the exception of times of economic
distress, US markets have got used to the idea of high long-term real interest
rates since 1980. As a result there is an assumption that this is the norm. Yet
the experience of the decades from 1955-1980 shows otherwise.
 While the 1970s can be classified as an aberration because high inflation
artificially lowered real 10-year interest rates in the US, this was not true for
the 1950s and 1960s. US real 10-year interest rates were low during that
period with an average either side of 2%. Which was a level close to the
average of the decade 2000-2010. So a long period of low real interest rates
would just be a return to the “old normal”.