Do Low Interest Rates Ensure High Asset Prices?

A Good Rate Hike for Europe

History shows that rising inflation is eventually followed by higher nominal interest rates.

An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

Central banks respond to lowered demand by reducing interest rates and to higher expected inflation by raising interest rates.

In this case, the price of loanable funds is the real interest rate. An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

With higher interest rates depressing housing prices, the game is over.

But higher energy prices, by themselves, will not cause the ECB to pull the interest rate trigger.

But interest rates have been increasing around the world since 2003.

This will change, however, once the economic pick up is confirmed. Interest rate hikes may be coming sooner rather than later, which is why Berlusconi and French President Jacques Chirac are talking up interest rate cuts now.

A hike, in other words, would indicate that good things are happening.

Moreover, the deficits would mean higher interest rates and continued international imbalances.

Remarkably, as short term interest rates rose, medium and long term interest rates did not, something that was referred to as a conundrum.

Interest Rates

But interest rates on US Treasury securities are very low and are not rising.

Such circumstances include, first, a high debt GDP ratio, with rising interest rates impeding growth.

With European interest rates up 200 basis points since late 2005 and the euro near a record high, Sarkozy wants the ECB to stop raising rates now.

The second adverse effect of deflation is to raise the real interest rate, that is, the difference between the nominal interest rate and the rate of inflation.

Ordinarily, a sharp rise in oil prices quickly translates into higher inflation expectations, followed by rising interest rates at all maturities.

No matter how high rates go, they think they re behind.

Corroborating statistical evidence shows that high deficits and debt increase long run interest rates.

In addition, a fall in the dollar could also push up inflation in the United States, leading to higher American and global interest rates.

Either way, a rise in long term interest rates is liable to choke off the recovery.

The euro is at record levels, oil prices are surging and interest rates are expected to go higher.

But lower short term interest rates have led to higher medium term interest rates, which are more relevant for the mortgage market, perhaps because of increasing worries about inflationary pressures.

Unemployment is rising, their economies are not becoming more competitive, and the interest rates on their debt continue to rise.

The high price of oil

Funds switched out of Japan have shifted to other financial markets, with the chase for yield driving up asset prices and lowering interest rates.

The Trouble With Interest Rates

When Interest Rates Rise

The Long Mystery of Low Interest Rates

The result in Japan would then be rising real interest rates as the low private saving rate runs head on into large fiscal deficits.

Inflation implies higher long term interest rates until markets regain confidence in the central bank.

A second argument is that higher oil prices are due to lower interest rates and anticipations of higher long term prices.

So what will happen when central banks start raising interest rates? In 1994, rising short term rates caused increases in long term rates and declines in long term bond prices that were at least double what standard models at the time were predicting.

Within a couple years, interest rates on long term US Treasury notes could easily rise 3 4 , with interest rates on other governments paper rising as much, or more.

And that is important, because a rise in the federal funds rate will cause other, somewhat longer interest rates to increase as well.

Thus, they run the risk that a spike in interest rates would feed back relatively quickly into higher borrowing costs.

Because the downturn was not caused by high interest rates, lowering them could not lift the economy out of recession.

This means that real interest rates interest rates measured in terms of goods and services have stayed the same.

Gold prices are extremely sensitive to global interest rate movements.

But, with longer term interest rates now creeping up slightly, the BOJ seems to be pausing. What did Kuroda and his colleagues expect?

First, while the US Federal Reserve continued hiking short term interest rates, long terms rates did not increase in tandem, which allowed housing prices to continue rising.

Back then, Europeans complained that low interest rates in America were driving global inflation now low US interest rates are blamed for driving irresponsible asset price booms.

Although it is difficult to anticipate how high long term interest rates will eventually rise, the large budget deficit and the rising level of the national debt suggest that the real rate will be higher than 2 . A higher rate of expected inflation would also cause the total nominal rate to be greater than 5 .