Re: poly: Why interest rates may stay low

From: Perry E. Metzger <>
Date: Sat Feb 28 1998 - 14:57:07 PST

Hal Finney writes:
> So the point of the flat supply curve is that the amount offered for
> investment is very sensitive to interest rates, a small increase in
> rates making much more money available. Therefore, unless demand for
> loans increases tremendously, interest rates can't go up much. The fact
> that historical rates stayed in a narrow range suggests that the curve
> has this shape.

Don't forget, btw, that money very rapidly shifts between equity and
debt investment. As the risk free rate of return increases in the debt
markets, money shifts from equity to debt (and vice versa). This tends
to have a stabilizing impact on both markets. A rapid rise in
effective interest rates tends to flood that market with money taken
from equities, thus reducing the rate of climb -- a reduction in
interest rates reduces the amount of money available to lend as
investors become more interested in equity investments. (The same,
btw, applies to other kinds of investments like commodity ownership --
changes in the effective rate of return rapidly moves money between
these markets.)

In modern times, the markets have also become more international as
swaps have made it possible to mitiate currency and other risks in
international transactions. The increase in the size of the market has
resulted in a rise in its stability.

However, I will point out that in spite of this, real interest rates
over the last several decades since the abandonment of the Bretton
Woods agreement have been far higher than "historical" levels -- that
is, the levels that it is claimed have been traditional for the last
few centuries.

You should also not forget the fact that the curves differ depending
on the length of time of the debt investment. The so-called "yield
curve" has dramatically different effective rates of return depending
on how long a period you are willing to invest your money for -- there
is no one "riskless" rate of effective return (nor, for that matter,
is there any instrument that carries no risk premium whatsoever). The
yield curve generally grants higher rates of return for long term debt
investments because of the added risk, although historically the curve
has inverted during periods of high inflation.

Lastly, I will point out that not all debt instruments issued are
"pure" -- many, like convertables or subordinated debt, tend to behave
like a combination of equity and debt investments. This clouds the
accurate measurement of the rates of return in these markets.

Received on Sat Feb 28 23:01:28 1998

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