What Eight Centuries of Interest Rate Data Tell Us

The History of Interest Rates: A Long-Term Perspective

Just a few months ago, the prevailing market consensus was that the Federal Reserve of the United States would cut interest rates six times this year, starting immediately.
However, recently investors have drastically reduced their expectations, with many now expecting rate cuts to be postponed until November.
Moreover, higher-than-expected inflation data has led Lawrence Summers, former Treasury Secretary, to warn that the next move might even be an increase in rates rather than a decrease.

A Deep Dive into Financial History

Amidst this debate, it is worth taking a moment to reflect on the long history of our financial system.
Three economists – Kenneth Rogoff, Barbara Rossi, and Paul Schmelzing – have gathered global data on interest rates and inflation since 1311.
Their conclusions highlight some fascinating points.

Looking beyond short-term interest rates, Rogoff and colleagues argue that examining long-term real rates reveals a clear and surprising trend: a consistent decline over the centuries, with an average annual decrease of almost 2 basis points since 1311.
Despite various upheavals, these long-term rates tend to revert to this trend.

The Role of Modern Finance

The decline in long-term borrowing costs has been attributed to various factors such as productivity, demographics, and capital flows.
However, Rogoff and his team found no statistical correlation between real rates and fundamental economic trends.
They propose that financial innovations and risk analysis have made money more efficient, contributing to this downward trend.

This cultural shift, accompanied by technological advancements, has increased the abundance and fluidity of money, reducing its cost.
Will this downward trend continue indefinitely, or will future technological advancements impact it? Only time will tell.

Implications for the Present

Looking over eight centuries, the ultra-low rates seen in the early 21st century were slightly off the long-term trend.
It’s not surprising that long-term rates have corrected upwards, especially considering short-term natural rates likely increased.
However, these short-term fluctuations are not unprecedented in the grand scheme of financial history.