The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival

by Charles Goodhart

An argument that has been put forward, e.g. by these authors, and also Marx, Mojon and Velde, ‘Why Have Interest Rates Fallen Far Below the Return on Capital?’ (2019), has been that aversion to risk and illiquidity has driven an increasing wedge between the return on capital and riskless interest rates. Because the required return on capital remained high, thereby deterring investment, riskless interest rates had to be lower in order to equilibrate the macroeconomy. We are not convinced by these arguments. If there was concern about illiquidity, then the wedge between relatively riskless bonds and riskier bonds ought to have expanded, i.e. the wedge between AAA and BBB corporate bonds ought to have increased. Diagram 6.5 shows the path of this wedge from 2006 to 2018. As shown by the chart, the wedge increased very sharply during the Great Financial Crisis, but has since declined steadily to its current low level. Indeed, one of the key purposes and features of recent monetary policy has been to try to encourage agents to take on more risk by reaching for yield, and the evidence is that they have achieved this objective.