A History of Interest Rates

Nominal yields on long-term government bonds have been constantly trending lower in the past 35 years, mainly driven by the lower global economic growth and the convenience yield for safety and liquidity. In addition, policy responses from both governments and central banks following the Great Financial Crisis have also contributed to the downtrend in LT interest rates globally, driving the term premium (investors’ compensation for holding interest rate risk) to negative levels.

Figure 1 represents the history of interest rates since the beginning of the 12th century up to today. The data source comes from Homer and Sylla’s book A History of Interest Rates (2005), which reviews interest rate trends in the major economies over four millennia of economic history. For the last 150 years, we compute a GDP-weighted average interest rate times series using a sample of 17 countries (Global LT interest Rate), using data from Jorda et al. paper The Rate of Return on Everything (2017).

One interesting observation was that in the past millennium, nominal interest rates have mainly traded below 10 percent, with two exceptions:

·         The first one is during the Spanish Netherlands period, which is the name for the Habsburg Netherlands ruled by the Spanish branch of the Habsburg. In the 16th century, Antwerp was one of the most important financial centres in the world, dominating international markets in sugar, spices and textiles. During a significant part of this century, the Exchange at Antwerp had dominated European transactions in bills of exchange and other credit instruments such as demand notes, deposit certificates and the bonds of states and towns (all short-term debts). Between 1508 and 1570 (when Antwerp defaulted on its debt), the interest rates were from loans by various bankers to the Spanish Netherlands government, Charles V and the city of Antwerp. We can notice that interest rates surged to 20% in the mid-1520s, and the bankers’ family, the Fuggers, made emergency loans to Charles V at annual rates as high as 24 to 52 per cent.

·         The second period of high interest rates was during the Great Inflation of the 1970s, which was marked by a sustained trend in inflation in the US that affected the rest of the World as well. A number of factors were associated to the rise in inflation during that decade: oil price shock following the 1973 embargo, speculation, avaricious union leaders and bad monetary policy management. As a consequence, long-term interest rates started to surge around the world, reaching a high of 14 per cent on average in 1981.

Interest rates globally are sitting at their lowest level in history, with the aggregate currently trading at around 0.5 per cent (probably trading between 1%-1.5% if we include some major EM economies to our times series of LT interest rates). As uncertainty has been constantly reaching new all-time highs (especially in the past year following the Covid19 shock) and growth expectations have been lowered accordingly, global yields have decreased dramatically since the last quarter of 2018 and broke below the lows reached in the late 16th century during the Republic of Genoa. At that time, Genoa became the banker for the Spanish Crown, a role previously held by German and Dutch bankers. The Bank of St. George was issuing placements or perpetual bonds called luoghi, which paid deferred dividends on the amount of taxes collected, after subtracting payment of the expenses of the bank.

The explanation of the persistence of very low real interest rates in advanced economies is a contentious issue. While many studies, including those by central bank research departments, stress secular forces such as demographics, over-indebtedness and dispersed income distributions – factors that emerged before the Great Financial Crisis – others find an important role for monetary policy in the determination of interest rates. On the secular view, a potential mean-reversion in long-term real interest rates must be driven by a global economic force such as a sustained period of above-trend economic growth. On the latter view, the monetary policy regime is endogenous to the real interest rate and the unconventional policies of the past decade are part of the explanation for low rates.

Figure 1. A History of Interest Rates

Source: Homer and Sylla, Jorda et al. (2017), Bloomberg, RR calculations

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