Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models

Abstract

MANY HAVE NOTED THAT we appear to be living in an era of low long-term interest rates and high asset prices. Although long-term rates have been increasing in the last few years, rates so far in the twenty-first century are still commonly described as low, in both nominal and real terms, compared with historical averages or with a decade or two ago. Meanwhile stock prices, home prices, commercial real estate prices, land prices, and even oil and other commodity prices are said to be very high.1 The two phenomena appear to be connected: elementary finance theory states that if the long-term real interest rate is low, the rate of discount used to determine present values will also be low, and hence present values should be high. This pair of phe-nomena, connected through the present-value relation, is often described as one of the most powerful forces operating on the world economy today. In this paper I will critique this common view about interest rates and asset prices. I will question the accuracy and robustness of the “low long rates, high asset prices ” description of the world. I will also evaluate a pop-ular interpretation of this situation, namely, that it is due to a worldwide regime of easy money. I will argue instead that changes in both long-term interest rates and asset prices seem to have been tied up with important changes in the public’s ways of thinking about the economy. Rational expec-tations theorists like to assume that everyone agrees on the model of the economy, which never changes, and that only some truly exogenous factor,

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