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A MUCH-GREATER MODERATION

What interest rates dating back to 1311 tell us about today’s global economy

Global economy insights dating back centuries.
Boccaccio's 'The plague of Florence in 1348'. Credit: Wellcome Collection. CC BY 4.0
It all goes back to the Black Death.
By Gwynn Guilford
Published Last updated This article is more than 2 years old.

Interest rates sure are weird these days. Five central banks currently hold policy rates negative; several are dabbling with unconventional bond-buying. The one bank that tried to raise them, the Federal Reserve, found itself back cutting rates within a year. Meanwhile, some $11 trillion worth of bonds have negative rates—guaranteeing losses for buyers that hold those to maturity.

But however weird this moment might be, it’s also entirely predictable—with the benefit of 700 years of hindsight, that is.

That insight comes courtesy of a fascinating working paper by economist Paul Schmelzing, which reconstructs real interest rates in advanced economies dating back to 1311. The study—what the author says is the first construction of a dataset of high-frequency GDP-weighted real rates (i.e. the difference between the nominal yield and inflation)—features a staggeringly rich collection of records culled from diaries, account books, local archives, and municipal registers and includes everything from Medici bank loans to France’s “Revolutionary loans” to the US government.

While the data available from past eras isn’t comprehensive, what it suggests is a steady fall in the average real rate since the late 1400s—a decline that spans centuries, asset classes, political systems, and monetary regimes. The slope of that trend puts long-term real rates on track to hit near-zero levels at some point in the past 20 or so years.

“Current real rate levels should have surprised nobody who had comprehensively charted long-run trends,” writes the author.

Of course, we commonly blame the current state of affairs on the 2007 global financial crisis—and central bankers’ subsequent response. But those critiques don’t square with the historical trend. “The 2007-2008 at best plays a minor cyclical role in explanation of low interest rate levels,” writes Schmelzing. “And the historical record does not imply that any presently-discussed fiscal or monetary policy action can generate any lasting trend break.”

It also turns out that, in the longer sweep of history, this eerie “new normal,” is not very new at all.

Apparently negative-yielding debt—often touted as a sort of late-cycle perversion, a sign of “just how crazy things have gotten”—is plenty frequent if you know where to look (i.e. way, way backward).

Between 1313 and 2018, around a fifth of advanced economies were experiencing negative long-term yields, on average. In keeping with Schmelzing’s larger finding, that share has risen over time. However, the frequency of these episodes seems to be rising. For example, the average share from 1313 to 1750 was 18.6%, compared to 20.8% from 1880 to 2018. Since 2009, that share stands at 25.9% (after an unusual spate of 0% between 1984 and 2001).

What’s behind the long trend in slumping rates isn’t clear. Economists looking to the recent past for culprits tend to identify changes in the pace of growth, productivity, and population size as chief drivers. Testing real GDP growth and demographic change against his dataset, the author finds no clear link.

One clue comes from the inflection point that gave way to the current trend in declining real interest rates. From the 1300s into the mid-1400s, capital costs began climbing. Then, all of a sudden in the late 1400s, credit conditions eased, as capital suddenly began pooling in great quantities, and savings rates seemed to jump.

Why might this have happened? There’s no sign of profit abruptly booming. Instead, it might have something to do with the Black Death.

In 1348, the bubonic plague arrived in Europe. Over the next few decades, it killed around a third of the continent’s population. By wiping out much of the workforce, the plague spread wealth more evenly. The trauma also left people inclined to spend like there was no tomorrow, according to chroniclers of the era. A consumer spending boom on everything from high fashion and booze to fancy eats and art followed.

Then came the moral backlash. Starting in the early 1400s, states around Europe instituted a rash of “sumptuary laws” banning myriad forms of conspicuous consumption. Schmelzing hypothesizes that the luxury retail boom sucked funds away from debt markets. After sumptuary laws finally succeeded in suppressing consumer spending, that trend reversed. Though there’s no micro-level evidence on savings rates to check this against, cautions Schmelzing, this surmise is consistent with narrative accounts and research on longer-term wealth evolution. As savings rates began climbing in the late 1400s, money flowed back into bonds, pushing down rates—and setting off the centuries-long decline that continues still today.

And, naturally, tomorrow. Later this decade, short-term real rates around the world will have dipped into permanent negative territory, according to the economist’s historical extrapolation. As for long-term rates, Schmelzing pinpoints 2038 as the year those go under.

Still, it might not be a smooth slide down the slope. Throughout the last 700 years, cyclical forces have temporarily bucked that long-term trend—at times causing rates to drop sharply for decades, followed by steep, abrupt reversals. We’ve been in the grip of one such “rate depression” since 1984. Pointing to Schmelzing’s earlier research on how past episodes have ended, Albert Edwards, strategist at Societe Generale, speculated that after a period of “deflationary bust, we may be on the cusp of one of these contra-secular snapbacks.”

So does that mean we shouldn’t be worried about negative rates and the way they warp the financial system? Nope—just that there’s nothing much to do about it.

“With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem,” writes Schmelzing,” but my evidence still does not support those that see an eventual return to ‘normalized’ levels however defined.”

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