Lower interest rates will boost economy


Interest rates are low.

The 10-year Treasury bond rate, which forecasters use as a benchmark, averaged 1.6 percent in August. That’s the third lowest monthly rate in the past 20 years.

The 30-year home mort- gage rate averaged 3.4 per- cent in August. That’s the fifth lowest rate in the past 20 years. The AAA-rated corporate bond rate averaged 3.3 percent, the second lowest rate in the past 20 years.

The rate on state and local government bonds, which governments pay to borrow for infrastructure such as schools and libraries, averaged 2.8 percent, only the second month it’s been below 3 percent since 1958.

Why are interest rates so low? An obvious answer is Federal Reserve policy. The Fed cut its policy interest rate to near zero at the end of 2008, to battle the Great Recession. Low inflation and slow growth have kept the Fed from raising rates much since then.

But low interest rates are not just a recent thing. Interest rates have been falling for 35 years. The 10-year Treasury bond rate averaged 10.6 percent in the 1980s, 6.7 percent in the 1990s, 4.5 percent in the 2000s, and 2.4 percent so far in the 2010s. Other interest rates show a similar drop.

Lower inflation is a reason for lower interest rates. Inflation erodes the purchasing power of the dollar, and lenders set interest rates higher than expected inflation in order to offset that erosion. Inflation rates were high in the early 1980s, and so were interest rates. Inflation is very low now, and interest rates are too.

Falling inflation is not the whole story, though. The difference between the Treasury rate and the inflation rate is a back-of-the-envelope measure of the “real” interest rate, the return lenders get above inflation. The real Treasury interest rate has been falling steadily, from 4.5 per- cent in the 1980s to 0.6 percent so far in the 2010s.

Consider a couple of explanations for lower real interest rates. China and the oil countries have been saving a lot more than they spend, and some of those savings are lent here. That holds our interest rates down.

Businesses aren’t borrowing to invest in new buildings and equipment, maybe because of slower population growth and a lack of investment opportunities. Lenders try to find borrowers by keeping interest rates low.

Interest rates matter for families and businesses, and they matter for state and local governments too. The state government earns interest on its $2 billion in balances, which is added revenue for education, health care and other state services. Back in 2006 when the Treasury bond rate topped 5 percent, the state earned $85 million in interest, on balances of about a billion dollars. Last year the state earned $23 million, on balances double that size.

Interest rates matter for local government borrowing. Voters will consider four bond referenda in November’s election, when three school districts and one library district will ask whether they should borrow for construction and renovation of their buildings.

For a $10 million bond over 20 years, the difference between paying 2.8 percent interest and 5 percent interest is almost $3 million. The tax rate needed to pay off a bond is lower with lower interest rates, and lower tax rates make voters a bit more likely to say yes.

Interest rates even matter for farmland assessment. There are a couple of interest rates in the farmland assessment formula. In the past, falling interest rates made for more rapid increases in assessed value, and that caused higher farmland property taxes.

Our new formula will cut farmland assessments if future interest rates stay low, and that will reduce farmland taxes.

Low interest rates are likely to continue. The Congressional Budget Office does 10-year forecasts of interest rates as part of their budget analysis. Back in 2010 they thought the Treasury rate in 2020 would be 5.6 percent. Now they’re saying 4.1 percent. Their idea of what’s “normal” for interest rates is falling.

So it’s not just the Fed. We’re in the midst of a long-run trend towards lower interest rates. And that means lower earnings on state balances, lower costs for school and library construction, and (under the new formula) lower farmland assessed values.

Your savings account won’t earn much. But your mortgage payment may be lower, too.

Larry DeBoer is professor of agricultural economics at Purdue University. Send comments to [email protected].

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