poly: Why interest rates may stay low

From: Robin Hanson <hanson@econ.berkeley.edu>
Date: Fri Feb 27 1998 - 11:23:56 PST

As technology and our economy grows, and more promising
investment opportunities are generated,
the average return on investments should rise, right?
Growth should accelerate, right?
"The future's so bright, I gotta wear shades."

Well, I've been thinking about this, and maybe not.
Consider a simple supply and demand model of investments,
with the interest rate being the equilibrium price and
the marginal return on investment, and the average return
being higher, given by the demand curve describing the
various possible investments technology allows. The
supply curve is given by the distribution of people's
marginal willingness to part with assets today in trade
for more assets tommorow.

First, one the supply side, there are good reasons to
think the supply curve is basically flat at about 1-2%.
This is the rate predicted by evolutionary analsysis,
being about a factor of two per generation. And I think
historical risk-free interest rates have stayed about
this number for many centuries. This is also the average
return on stocks worldwide over the last century, once
you account for selection effects.

On the demand side you have to realize that over the long
term there aren't really property rights over most of the
main technological investments. Most any company or nation
could try to be the future providers of telecom, software,
banking, electronics, toys, or whatever. The game is
wide open. But that means they all entrants should expect
to make about the same return on investment (though of
course actual returns can vary widely).

How does this square with an image of a downward-sloping
demand curve given by the available investments, with
the average return higher than the marginal return?
It squares by realizing that while there might be an
optimal time to make any one investment, say trying to
create an internet directory, the investment will happen
at the first time that it's expected return reaches the
going interest rate. That is, without property rights,
there is a race to be first, a race which burns up all
the value of the investment over the marginal rate.

So regardless of how much technology makes investments
intrinsically profitable, without property rights the
average return on investment stays at the marginal rate,
which is determined by our evolutionary heritiage on
discounting time, at 1-2%/year. And to the extend that
growth rates are tied to the average return on investment,
growth rates will also say moderate.

Now consider for the moment a population of uploads and
ordinary people, with uploads running much faster. The
uploads discount time much faster, so they won't find it
in their interest to invest their resources until interest
rates are much higher than they are now. So the humans
do most of the saving, and so own most capital, and keep
interest rates at 1-2%/year.

Now maybe if we get far enough out on the supply curve,
it hits a wall and goes up real fast, then interest rates
could rise up to where fast uploads would find them
interesting. But I suspect the big effects are mediated
by the risk-premia, where rates may rise as compensation for
various sorts of risk. I wish we understood these better.

Robin Hanson
hanson@econ.berkeley.edu http://hanson.berkeley.edu/
RWJF Health Policy Scholar, Sch. of Public Health 510-643-1884
140 Warren Hall, UC Berkeley, CA 94720-7360 FAX: 510-643-8614
Received on Fri Feb 27 19:28:37 1998

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