A HISTORY OF INTEREST RATES PDF
This revision of A History of Interest Rates by Richard Sylla is exceed- ingly timely . them in historical perspective in the way that Sidney Homer would. A History of Interest Rates FOURTH EDITION. A History of Interest Rates presents a very readable account of interest rate trends and lending practices over four millennia of economic history. Despite the .
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Case when rate of return on cost exceeds rate of interest. 3. Roscher's fishing implicit interest is recognized; and, as a matter of history, it was only after. Within any economy there will therefore be a multiplicity of interest rates, reflecting that, for much of human history, charging such rates of interest has been a. Neil Irwin had a really great write-up at The Upshot this week about the history of interest rates. He made the case that low interest rates may be.
The real interest rate, that is the nominal interest rate minus expected inflation, is the rate that influences decisions concerning saving and investment. The interest rate influences inflation indirectly via domestic demand for goods and services and via its effect on the exchange rate. When the interest rate falls, it is less profitable for households to save, and they will therefore increase their consumption now rather than wait until later.
Borrowing also becomes less costly, with an associated rise in investment. Higher demand in turn leads to a higher rise in prices and wages. Lower interest rates make it less attractive to invest in NOK and less attractive for Norwegian enterprises and households to raise loans in other currencies. Lower interest rates will therefore normally result in reduced capital inflows and a weaker krone.
This makes imported goods more expensive. In addition, a weaker krone increases activity, profitability and the capacity to pay in the internationally exposed sector.
The equilibrium interest rate and the neutral interest rate are closely related concepts. The neutral interest rate is the rate that does not in itself result in an increase or a reduction in price and cost inflation in the economy in the course of a business cycle.
An assessment of whether interest rate setting is expansionary or contractionary, involves comparing short-term market rates with the neutral rate. A real interest rate in the interval 3 - 4 per cent is often regarded as neutral in economies such as the Norwegian economy. I will revert to a quantification of this level later. In the longer term, the interest rate level influences capital accumulation in the economy and the potential for economic growth.
The equilibrium interest rate is the rate that ensures that capital accumulation corresponds to saving in the economy. This results in an output potential that over time satisfies demand without generating pressures in the economy.
The equilibrium interest rate is determined by long-term phenomena associated with the structure of the economy, while the neutral rate is defined on the basis of its influence on pressures in the economy and thereby on inflation. In the long term, the neutral interest rate will correspond to the long-term equilibrium interest rate in the economy.
The long-term equilibrium interest rate is determined by fundamental structural relationships in the economy, such as consumer impatience and the economic growth rate.
Rising population growth means that a larger labour force must be equipped with real capital. Fixed investment and saving must increase. Higher population growth will therefore require a higher equilibrium interest rate.
The higher productivity growth is, the higher future gains from today's investments will be. This also provides the basis for a higher equilibrium interest rate. The long-term equilibrium interest rate cannot deviate too much between countries over time.
With liberalised capital markets, capital will move towards those countries that can provide the highest return. Substantial interest rate differentials between countries cause fluctuations in the exchange rate and will not be compatible with a long-term equilibrium.
Thus, we may refer to a global equilibrium interest rate for open economies, although perhaps with an added national risk premium. The interest rate has thus several roles to play in the economy and these roles should be fairly closely linked. The interest rate shall in the short and medium term contribute to stable inflation and stable developments in production.
At the same time, it shall in the long term also contribute to equilibrium in the market for real capital. Capital accumulation shall over time correspond to saving. To achieve this, the real interest rate must not over time deviate substantially from the return on real capital. Substantial deviations can give rise to undesirable fluctuations in the markets for real capital that have no basis in economic fundamentals.
The economic situation varies over time.
Monetary policy will set an interest rate that is alternately above and below the neutral rate. Consequently, the interest rate level will probably not deviate substantially from the long-term equilibrium rate over time. By taking a gradualist approach to interest rate setting, it is also possible to assess whether imbalances are developing in capital markets. Interest rate developments from a historical perspective In the long term, the equilibrium real interest rate will be determined by underlying structural relationships in the economy.
These relationships will probably only be changed gradually so that changes in nominal rates will primarily reflect changes in expected inflation.
In the short term, however, the real interest rate will vary, not least because monetary policy seeks to influence the real interest rate in the short and medium term. Changes in nominal interest rates might therefore reflect changes in both real interest rates and inflation expectations. Nominal interest rates were relatively stable from the s and up to the s.
The gold standard set the framework for monetary policy at the end of the s and up to Central banks had to keep stocks of gold that could be used to stabilise the gold price by actively buying and selling gold in the market. The money supply and inflation in a country are then determined by the supply of gold on the world market.
When two or more currencies are pegged to gold at a fixed price, these currencies will also have a fixed price in relation to each other. As in other systems with fixed exchange rates, this restricted the individual country's scope for using the interest rate as an instrument to stabilise the real economy.
In the interwar years, nominal interest rates were relatively high.
This may primarily be ascribed to the policy of gold parity that was pursued in many countries. The aim of a number of countries, including Norway, was to strengthen the value of the national currency against gold, so as to re-establish the gold parity of the pre-First World War period. Nominal interest rates increased markedly from - , reflecting accelerating inflation in this period.
After , nominal interest rates fell again and are now at about the same level as in the interwar period. At the same time, short-term variations in nominal interest rates seem to have increased. This may be related to central banks' more active use of interest rate policy to combat inflation. Developments in inflation since have been remarkably similar from country to country.
This is not a new feature that has coincided with the market globalisation we have witnessed in recent years.
It would appear that inflation is particularly low in periods when monetary policy has a clearly defined nominal anchor. Up to the First World War, the gold standard was that anchor, providing a direct link between the supply of gold and inflation.
Whenever gold was discovered, the gold price dropped. In order to fulfil its commitment to maintaining the fixed price between a country's currency and gold, the central bank was obliged to buy gold using the national currency as payment. The supply of money then increased, which contributed to inflation. In periods when no new gold finds were made, prices tended to be stable or falling.
The tendency for prices to fall was amplified in periods of strong economic growth. Economic growth is accompanied by higher turnover. Unless new money is printed to accommodate this, prices must fall. After , with the introduction of the Bretton Woods system, a number of countries' currencies were pegged to the US dollar, which was in turn pegged to gold until In many ways, US monetary policy and nominal interest rate levels functioned as a nominal anchor, and to a large extent governed global interest rates and inflation developments.
Inflation has been particularly high in times of war. The s and s were characterised by fairly high inflation following the collapse of the Bretton Woods agreement, the oil price shocks and counter-cyclical policy.
From the end of the s, an inflation target for monetary policy has functioned as a credible nominal anchor in a number of countries, curbing the pace of inflation. To calculate historical real interest rates, an estimate must be made of expected inflation. Figures for actual inflation are normally used. Inflation expectations may deviate from actual inflation, especially in periods when the latter is subject to considerable fluctuation.
From to today, developments in global real interest rates can be roughly divided into 5 periods. In the period - , the real interest rate ranged between 4 and 5 per cent, and inflation fluctuated around zero.
No new major gold finds were made in this period and the economy in general was exhibiting brisk growth. The real interest rate fell to about per cent in the period , reflecting some acceleration in inflation in this period.
Sidney Homer & Richard Sylla - A History Of Interest Rates.pdf
New discoveries of gold were again made in this period. In the s and up to the First World War, the gold standard and price fluctuations in the agricultural sector contributed to alternating inflation and deflation. In the interwar period , real interest rates were fairly high, sometimes well above 5 per cent. This was partly due to the policy of gold parity and the reestablishment of the gold standard, which resulted in high nominal interest rates in a number of countries.
The post-Second World War era can be divided into two periods. The post-war period up to the collapse of the Bretton Woods agreement in was characterised by unusually low real interest rates, ranging from 0 to 2 per cent. Real interest rates were low despite high returns in the stock market, strong growth in output and in stocks of real capital.
According to most economic growth theories, this should have been accompanied by a high real interest rate. From a more short-term perspective, however, low real interest rates led to high investment activity and growth. However, this probably contributed to the tensions that led to the marked changes in economic policy in the s and s, internationally and in Norway.
To a certain extent, a negative real interest rate characterised the s and most of the s in Norway. In retrospect, we might ask whether the interest rate was kept too low in relation to a reasonable long-term equilibrium level. In particular, this was a period of substantial fluctuations in the Norwegian economy, with high and variable inflation. The absence of a nominal anchor was one of the main reasons behind these pronounced swings in the Norwegian economy.
Because of the extensive use of credit regulations, nominal interest rates remained low. With a policy of low interest rates and devaluations, inflation took root. Nominal interest rates were kept at a low level even though inflation and the value of tax- deductible interest expenses rose.
The wide fluctuations culminated in a credit boom in the mids, followed by a deep recession and high unemployment towards the end of the s. From the mids, during and after the credit bubble, it was recognised that a substantial revision of economic policy would be necessary and that the problems created by inflation had to be taken seriously. The exchange rate was chosen as the nominal anchor.
The real interest rate gradually rose and was relatively high until the mids, partly as a result of the tight monetary policy that was conducted in order to reduce inflation.
The real interest rate has fallen markedly since the beginning of the s. Neither the neutral interest rate nor the equilibrium interest rate are variables that can be observed. Economic theory can contribute insight into the factors that determine the equilibrium rate, but attempts to quantify the equilibrium interest rate based on theory yield a broad interval for a possible level. Quantification also presents problems, as estimates must be made for unobserved variables such as consumer impatience.
The upper limit in particular seems unreasonable in relation to observed real interest rates, for example. An alternative is to use historical average interest rates on the basis of an assumption that actual real interest rates will vary around the equilibrium interest rate. This method also poses problems. Each historical era will, for example, be affected by the specific characteristics of that era. Credit rationing, for example, has influenced interest rate formation for long periods.
In addition, both population and productivity growth have varied over time. Throughout the period , the average for long-term real interest rates in Norway has remained close to the average in the UK and the US: Norway 2. The economy has changed substantially in this period. Thus, the average for this period probably provides little indication of what a long-term equilibrium interest rate is today.
In order to comment on whether the real interest rate today is low or high, it may therefore be more meaningful to look at a "representative" period when the structure of the economy was more similar to the current structure. It is most reasonable to examine a period in the recent past, for example the past years. Markets were deregulated in this period, for example. For Norway, it would also be natural to study the period after In the period , the average real interest rate for Norway was 4.
Since , the long-term real interest rate in Norway has varied between 3 and 6 per cent, reaching its highest level at the beginning of the period and its lowest in the years Both the Norwegian and the global economy have now entered a period of low real interest rates. The low interest rate level must be viewed in the light of the possibility of persistently low inflation both in Norway and other countries. However, the real interest rate is not by any means as low as when inflation in Norway was high in the s and s.
Various monetary policy regimes As long as capital markets have been in existence, the interest rate has had the key role of creating equilibrium within and between the various markets. The interest rate's role as a monetary policy instrument used to influence inflation, however, is a more recent phenomenon. The gold standard was introduced in Norway as the basis of the Norwegian monetary system by the Act of 4 July relating to the Monetary System.
Norway's monetary system was largely based on the gold standard until its international collapse in , when the Norwegian krone was pegged to the pound sterling. Up to the mids, the focus of monetary policy was, first, to stabilise the exchange rate by means of interventions and regulation of international capital movements.
A Short History of Interest Rates
Second, credit developments were governed by regulations on borrowing. The interest rate was primarily used to provide cheap credit for some sectors. Many other countries have followed a similar path of development. In many countries, the authorities have increasingly focused on price stability as the long-term objective of monetary policy, with the interest rate as the most important policy instrument.
The nominal interest rate the key rate will thus be set by central banks with the objective of achieving a level of actual inflation that is equal to the inflation target. Provided there is confidence in monetary policy, expected inflation will remain consistent with the inflation target. Changes in nominal interest rates will then be fully reflected in real interest rates. This makes monetary policy more effective. The changes in Norges Bank's monetary policy over the past 25 years are largely in line with international developments.
In Norway, the interest rate was used to stabilise the exchange rate from Capital regulations no longer had the desired effect and were removed. Events in international financial markets in the last half of the s led to more pronounced fluctuations in the exchange rate and demonstrated that the exchange rate cannot be finely tuned. High petroleum revenues, fiscal slippage and expectations of an increase in the use of petroleum revenues contributed to eliminating the effect of interest rate policy on wage formation and fiscal policy.
The exchange rate was no longer suitable as a nominal anchor. The Government laid down new monetary policy guidelines in March The OECD countries have placed greater emphasis on inflation targeting through the s. This has had a substantial effect on the largest capital markets in the global economy, i. Capital markets outside these areas are small. However, changes are also being made in monetary policy regimes in a number of emerging markets. One important tendency is that fewer countries operate an exchange rate policy regime where they are free to change the conversion rate to other currencies on their own initiative, so-called "crawling pegs".
Other countries, such as China, Hong Kong and the Baltic States, have chosen to continue to use a fixed exchange rate system. The operational target of monetary policy in Norway as defined by the Government is inflation of close to 2. The inflation target provides economic agents with an anchor for their decisions concerning saving, investment, budgets and wages.
The inflation target is also a vehicle for allowing monetary policy to stabilise developments in output and employment. This objective is also expressed in the Regulation on Monetary Policy. High demand for goods and services and labour shortages normally point to higher inflation. When interest rates are increased, demand falls and inflation is kept at bay. When demand is low and unemployment rises, inflation will tend to slow.
Interest rates will then be reduced. This orientation of monetary policy will normally also contribute to stabilising output and employment. The impact of monetary policy occurs with a lag. The current inflation rate does not provide sufficient information to determine the level at which interest rates should be set now. Example[ edit ] A company borrows capital from a bank to buy assets for its business.
In return, the bank charges the company interest. The lender might also require rights over the new assets as collateral. A bank will use the capital deposited by individuals to make loans to their clients. In return, the bank should pay individuals who have deposited their capital interest. The amount of interest payment depends on the interest rate and the amount of capital they deposited. Related terms[ edit ] Base rate usually refers to the annualized rate offered on overnight deposits by the central bank or other monetary authority.
A discount rate is applied to calculate present value. For an interest-bearing security, coupon rate is the ratio of the annual coupon amount the coupon paid per year per unit of par value, whereas current yield is the ratio of the annual coupon divided by its current market price. Yield to maturity is a bond's expected internal rate of return , assuming it will be held to maturity, that is, the discount rate which equates all remaining cash flows to the investor all remaining coupons and repayment of the par value at maturity with the current market price.
Based on the banking business, there are deposit interest rate and loan interest rate. Based on the relationship between supply and demand of market interest rate, there are fixed interest rate and floating interest rate. Based on the changes between different interest rates, there are base interest rate and cash interest rate. Monetary policy[ edit ] Interest rate targets are a vital tool of monetary policy and are taken into account when dealing with variables like investment , inflation , and unemployment.
The central banks of countries generally tend to reduce interest rates when they wish to increase investment and consumption in the country's economy. However, a low interest rate as a macro-economic policy can be risky and may lead to the creation of an economic bubble , in which large amounts of investments are poured into the real-estate market and stock market. In developed economies , interest-rate adjustments are thus made to keep inflation within a target range for the health of economic activities or cap the interest rate concurrently with economic growth to safeguard economic momentum.
Forces That Causes Changes In Interest Rates
For example, the Federal Reserve federal funds rate in the United States has varied between about 0. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation. The quick boost can influence elections. Most economists advocate independent central banks to limit the influence of politics on interest rates.
Deferred consumption: When money is loaned the lender delays spending the money on consumption goods.Rates for previous years:. This, in turn, will increase the interest rates in the economy.
Low real interest rates will in the short term stimulate economic growth and contribute to preventing deflation. The U. And as the supply of credit increases, the price of borrowing interest decreases. Substantial deviations can give rise to undesirable fluctuations in the markets for real capital that have no basis in economic fundamentals.
The long-term equilibrium interest rate cannot deviate too much between countries over time. A landlord must give a tenant a receipt for a security deposit that includes the owner's name, the date it was received and a description of the dwelling unit. The interest rate shall in the short and medium term contribute to stable inflation and stable developments in production.