Do Ultra-Low Interest Rates Distort Asset Prices?

Image Description
Feb. 17, 2021
Share:

It is often insinuated that abnormally low nominal interest rates distort asset prices. This inturn drives mis pricing of assets and undue risk taking. And in turn this results in bubbles. This is quite intuitive. But, the relationship between nominal interest rates and asset prices is not that straight forward. Let us take property prices as an example. In Japan property prices are even today (as of mid-2020) down more than 50% of the peak they reached in early 1990s. And the trend has been down for the past 3 decades. This is despite nominal interest rates being low since the mid-1990s - long bond yields have been below 1% in Japan since 1995.

Contrast that with the USA where property prices are at an all-time high currently. They fell post the Global Financial Crisis in 2008 but rebounded sharply thereafter. Barring that correction post the GFC, property prices in USA have generally been in a broad uptrend since the 1970s - through the stagflation of late 1970s and early 1980s. Through the Volker era policy tightening, the boom of 1990s, the dotcom bust of late 1990s and the boom of 2000s.

This is not to suggest that nominal interest rates do not matter. Of course, they matter. But they are one of the several factors that impact asset prices. Other factors can easily overwhelm low interest rates like they have done in the case of property prices in Japan.


Like what you're reading? Subscribe to our Insights.