Why are interest rates so low?

She examines the period from 1945 to 1968. She tells us that during that period the real interest rate on Australian bonds was below 3% in 92.3% of the years. She tells us that the real interest rate on Australian bonds as below 2% in 80.8% of the years. She tells us that the real interest on Australian bonds was below 1% in 65.4% of the years. Most importantly she tells us that the real interest rate on Australian bonds was below zero percent in 48.0% of the years.

What this means is that in the post war period, real interest rates on bonds in Australia was so low that they were reducing the real level of public debt in 48% of the years. The holders of Australian bonds were losing money in real terms around one year in every two.

Reinhart notes that investors in UK and US bonds were doing not much better. Investors in UK bonds received a negative real return in 47.8% of the years. Investors in US bonds received negative real returns in 25% of years.

To reduce sovereign debt relative to GDP only requires that the real level of debt grows more slowly than the real level of GDP. As long as the budget is balanced, debt to GDP will fall by the growth rate of nominal GDP (real GDP plus inflation) minus the interest rate on sovereign debt.

She says that "for the United States and the United Kingdom, the annual liquidation of debt by negative interest rates amounted on average from 3% - 4% of GDP a year. Obviously, annual deficit reduction of 3-4% of GDP quickly accumulates (even without any compounding) to a 30% - 40% of GDP deficit reduction in the course of a decade. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5% per annum)."

Are we facing a new period of financial repression?

In Figure 2 below, we see the relationship between the real yields on US 10 year bonds and the level of net sovereign debt as a percentage of GDP in the developed countries shown in Figure 1. A model of the relationship between these two variables tells us that each 1% increase in net sovereign debt in developed economies will reduce the equilibrium yield on US 10 year bonds by 6 basis points. The T statistic of this relationship is 13.7. This means that the probability of this being a chance relationship is less than 1 chance in 10,000.

We can see that the relationship exists. The US 10 year bond is the benchmark bond of all world bonds. A lower real yield on the US 10 year bond means that all real bond yields will be lower. The result is that the higher level of sovereign debt in developed countries gives us a lower level of real bond yields in all developed countries (all other things being equal).

As long as this level of sovereign debt is high, we will have an extended period of lower real bond yields. This will have the positive benefit of allowing the repayment of this sovereign debt over an extended period as it did after World War II.

Why is this happening?

Let us go back and look at the world of Minsky. Minsky told us that when debt rises relative to GDP, interest payments consume a higher proportion of national income. The result is an enforced increase in savings. When savings increases, consumption falls. So, the result of a high level of sovereign debt in developed countries means a lower level of demand or consumption in developed countries.