NCPA - National Center for Policy Analysis

Why Are Interest Rates So Low?

January 30, 2012

Despite frequent, dire warnings about the unsustainability of government budget deficits in the United States, Europe and Japan, investors are lining up to lend to some governments at very low interest rates, says John Makin, a resident scholar at the American Enterprise Institute.

  • Ten-year U.S. treasury notes are trading at approximately 2 percent and three-month notes have at times actually promised negative returns.
  • Germany, the bull of the European Union's economy, has its trading at approximately the same level.
  • Japan has even seen its 10-year bonds dip below 1 percent.

Behind these incredibly low interest rates, which in the United States are almost record lows, are three persistent factors that have kept rates low and will likely continue to do so into the near future.  First, fears of inflation are minimal internationally.  U.S. inflation has been falling for the past four months and is expected to continue.  Inflation in Germany is following a similar behavior, and Japan's currency is actually experiencing deflation.

The second reason for the low rates is that there is little growth in the world's most stable economies.  As the United States, Germany and Japan stagnate and the Chinese economy begins to slow down, investors have few safe options in the private sector in which to participate.

  • Europe on the whole, plagued by debt crises and fears of bank insolvency, is expected to experience a recession in 2012.
  • Japan will also likely experience negative growth.
  • The United States, though briefly optimistic about the 3 percent growth posted in the final quarter of 2011, is still expected to maintain 2 percent growth for 2012.

The third and final reason has been the gradual erosion of investor confidence in a largely uncertain international market.  When individual investors are bombarded with stories of political upheaval like the Arab Spring and natural disasters like the Japanese-tsunami-turned-nuclear-accident, they tend to distrust risky assets in security markets and flock instead to sovereign debt.  This ample supply of investors clamoring to buy government bonds and notes drives down interest rates.

Source: John Makin, "Why Are Interest Rates Presently So Low?" Real Clear Markets, January 25, 2012.

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