Executive Summary

  • Yields on European sovereign bonds have reached historically low levels in 2016, to between 0 percent and 1.5 percent in most cases, compared to above 10 percent at the beginning of the 1980s. This secular decline in long-term sovereign yields is not limited to the euro area, and can also be observed in the United States, the United Kingdom and Japan.
  • The decline in yields over the last 30 years and the most recent fall are the result of various factors: reduced inflation, low risk premia in European countries and, most importantly, the fall in the real (ie inflation adjusted) interest rate.
  • The decrease in the real rate is itself driven mainly by the secular decline of the ‘neutral’ rate – the short-term equilibrium rate between demand for and supply of funds compatible with full employment and price stability.
  • Central banks therefore cannot be blamed for the actual level of long-term real rates: they adopt, to fulfill their mandates, the necessary policies to influence market rates in order to make them consistent with neutral rates, over which they have little influence.
  • Given that the neutral rate is an important guide to monetary policy (and a good benchmark to determine if the current level of rates is justified), a growing empirical literature has tried to estimate where this neutral rate is.
  • Although there is uncertainty around the results, there is some evidence of time-variation in the neutral rate, with a downward trend since the 1980s. This suggests that the decline in real rates of the last 10 years is not the result of an overly accommodating monetary policy but of a combination of structural and cyclical factors.
  • The determinants of the fall in the neutral rate are all the factors affecting the supply and demand for funds. These include demographics, lower productivity growth, lower investment, rising inequality and shifting preferences for less risky assets.
  • The disappointing recoveries in advanced countries have raised the possibility that we might have entered a period of secular stagnation. Understanding the mechanism at work behind this phenomenon could thus be crucial to understand why rates are currently so low.
  • The main driver of secular stagnation appears to be the structural mismatch between the high proclivity of people to save and the low demand for those savings to be translated into risky productive investment, leading to a lower and possibly negative real interest rate to clear the market for funds.
  • Although secular stagnation is an appealing hypothesis that provides an explanation for many of the economic features of the last 30 years, including the decline in real rates, it is too early to settle the debate. Nevertheless, even if secular stagnation remains a hypothesis, most of the structural features of secular stagnation are already weighing on growth and on interest rates.
  • Low rates are the symptoms of our diseases, not their cause. It is therefore crucial to tackle the structural causes behind the fall in long-term rates, but also to find solutions for the harmful consequences that lower equilibrium rates could have for the conduct of monetary policy.