Goodbye, Negative Real Interest Rates
A feature of the 1970s was negative real interest rates, meaning inflation rates throughout the economy were higher than borrowing costs. There are different ways to measure real – or inflation-adjusted – interest rates, but 2023 ended another brief era of negative real interest rates.
The 10-year U.S. Treasury Inflation Indexed Securities (TIPS) is a common inflation-adjusted interest rate product. Unfortunately, data are only available since 2004 (here), but real rates were negative between January 2020 and April 2022. Previously, these rates were negative between late 2011 and June 2013. It’s worth mentioning that it’s more likely for the inflation-adjust interest rates on U.S. Treasuries to turn negative as those nominal rates are lower than what any individual or farm can borrow.
Figure 1 shows the inflation-adjusted U.S. Prime rate on an annual basis since the 1950s. For 2023, preliminary data reveal the real Prime Rate at 3.2%. In 2021, real rates were -1.4% and -3.14%. While real rates posted a large year-over-year change from 2022 to 2023 (more than 600 basis points), the upturn was largely a return to normal, as the average rate since 1956 was 3.15%.
In only one other period in this data series – 1974 to 1975 – were real rates also negative. While negative rates were brief during the 1970s, real rates were persistently low throughout the decade. Between 1971 and 1980, real rates averaged 0.97%. Lastly, for additional context, nominal rates and inflation were substantially higher during the 1970s. In 1975, real rates were -1.29% from a combination of the Prime Rate at 7.85% and inflation at 9.14%.
At the farm level, preliminary data pegs real non-real estate farm interest rates at 2.67% in 2023, up from -1.78% in 2022 and -1.63% in 2021. These data are only available since 1977 – after the U.S. Prime Rate turned negative – but show that rates in 2021 and 2022 were the first time many agricultural producers lived through negative real interest rates.
While rates will be higher in 2023, they will remain historically low. Between 1990 and 2010, real farm interest rates averaged 4.7%, considerably higher than today’s levels.
Wrapping It Up
Negative real interest rates can have a way of fueling market exuberance. If borrowing money costs are less than inflation, it reduces the burden of servicing debt and leaves some wondering, “Why wouldn’t I borrow at low nominal rates and repay with future, inflated dollars?” Negative interest rates certainly don’t diminish inflationary pressures.
With negative real rates behind us, it’s worth considering how aggressive the Fed’s rate hikes have been. In real terms, conditions have returned to something closer to normal. Furthermore, current levels are considerably lower than observations throughout the 1980s and most of the 1990s. One could argue that the recent rate hike hasn’t been nearly as aggressive as the real hike deployed by the Fed during the early 1980s.
Remember that real rates will change due to shifts in nominal rates and inflation. Looking ahead, real rates can fall or rise due to Fed activity, inflation, or a combination.
Still curious? We discussed negative real inflation rates throughout the AEI.ag podcast season Escaping 1980, which you can check out wherever you listen to podcasts or stream here.