Tyler Cowen quote and asks

Inflation-protected securities sold at negative yields for the first time ever on Monday as traders anticipate that the Federal Reserve will start a new round of asset purchases.

There are liquidity issues, hedging issues, reinvestment risk issues, supply-side finance management issues, and so on.  This does not show that our real economy has a negative real rate of return.  Maybe, for reasons of institutional constraint, people buy these securities as an inflation hedge rather than investing in the real economy.  Still…

There is more here.

Question: When the measured expected real return is below zero, how well can any recovery program work?

There are of course the issues he mention but at its core is the problem the fact that Treasuries have zero risk. If people are risk averse enough or the uncertainty is high enough then the equilibrium real rate of return will always be negative.

Indeed, we abstract away from this in the growth models but it is entirely consistent for the economy to have constant risk-free negative real rates and be growing like gangbusters.

This would simply mean that people are highly risk adverse and storage costs are high. It takes negative real rates to get people out of treasuries and into those investments with high expected value but high variance as well.

About these ads