Maurits C. Boas Chair of International Economics at Harvard University Kenneth Rogoff joins Yahoo Finance Live to discuss long term interest rate trends, inflation, the state of the economic environment, and the outlook for U.S. banking.
- Despite yesterday's quarter-point interest rate hike, Fed Chair Powell says there's more work ahead to get inflation below the Fed's 2% target. Here with a look at all of this and what it means for the bigger picture is Kenneth Rogoff, professor of economics at Harvard University and former chief economist at the IMF. Ken, really great to see you here today. Big--
KENNETH ROGOFF: Same.
- --big picture, you've been writing about this in the FT, and you've gone back over 700 years with respect to interest rates and longer-term interest rates. And I want to get your broad strokes as to what this means for the current economic environment because we saw a huge dip in rates over the global financial crisis that lasted for years. And I believe-- and correct me if I'm wrong-- you're saying probably not going to happen this time around, and we're probably facing higher inflation that the Fed is going to be fighting for years to come. Just wondering if you can put that into some of the terms and what you discovered in your work.
KENNETH ROGOFF: Well, I mean, simply put, there is a very slight downward trend in real interest rates over long periods. Think of a one to two basis points a year. But the 10-year Treasury, forward-looking inflation index, interest rates or other comparable ones around the world fell 200 to 300 basis points in a short period after the global financial crisis.
And that has happened before. And typically, when that does happen, there's reversion to mean. It's not super fast. It might take 5, 10 years. But it's not permanent. And so I think the expectation should be that real interest rates are significantly higher over the next decade.
Now, will they be significantly higher over the next six months? Well, if we go into a deep recession and there's a financial crisis, maybe not. But I think they would come back pretty quickly. This isn't like 2008. We have inflation, which really wasn't an issue then. We have a huge shift in public and private debt from the financial crisis and the pandemic. There is big expenditures needed for defense, for green energy transition.
Populism is pushing, you know, a lot more transfer of income and spending. A lot of pressures pushing up interest rates that are the proximate reasons that this is probably going to, you know, see higher rates. So I worried about some kind of financial crisis coming quite some time ago because, inevitably, it does when you have a shift like this.
- And here we are, we have at least a banking panic. And you're writing and you wrote in the FT you're surprised-- or we should be thankful, excuse me, that this did not happen sooner. Can you outlay-- or can you lay out some of your reasoning here?
KENNETH ROGOFF: Yeah. Simply put, obviously when interest rates have been ultra low for a long time, and different people react to that differently, but a lot of people sort of, you know, went very long on that idea that they've been below forever, and it was a good moneymaker for a long time. And then when they go up, you get caught out. I mean, what happened to Silicon Valley Bank is maybe a little extreme in its naivety, but almost any kind of investment strategy that had illiquid assets, longer-term assets is going to lose money like this.
Now, I first was writing about this a few months ago. I didn't know it would be in the US banking sector. I was thinking, I don't know, maybe Japan, Italy, which might still be yet to come. But it's a worldwide phenomenon. This isn't a US banking problem. Obviously, we have the Credit Suisse, but it's much broader than that.
- And I'm wondering, you're also talking about in the article some of the problems with commercial real estate. They operate on a much longer time frame than, I guess, the private-- than other parts of the real estate market, in terms of residences. I'm just wondering what the potential fallout there is and what-- anything that you're seeing on the horizon for commercial real estate.
KENNETH ROGOFF: Well, I mean, the situation with commercial real estate is quite grim, clearly, in the United States, especially, where office occupancy is maybe half of what it was before the pandemic and doesn't see signs of springing back. And at the same time, interest rates are going way up, which would have been bad for commercial real estate even if we didn't have the pandemic. It may be that that's something that just drips out over time. Banks, financial firms lose money. It affects lending conditions, but doesn't lead to a crisis.
I think the point is, is that even if nothing further happened besides what happened two weekends ago and with Credit Suisse, we are going to see tighter lending conditions. Chair Powell emphasized that yesterday. First of all, they're, you know, worried-- some small banks are losing money to big banks, and they do a lot of the lending.
They're worried the regulators are coming for them after they've done this massive deposit insurance. And there's general nervousness about what's next. So that's what a banking crisis-- it's the tightening lending conditions that's the big thing that hits the economy. So we're certainly going to see that.
That said, if we're looking at the world as a whole, I believe we're just experienced the first wave of this and there are more to come. Not necessarily next week, two weeks. Remember the European debt crisis? It was sort of one month Greece, and then a couple of months later Ireland, and a few months later Portugal, et cetera. That's a very typical pattern in which these things unfold.
- Yes. And the key back then was Draghi, head of the ECB at the time, saying anything it takes, and just pledging that underlying support. Bringing it back to the president with Chair Powell and what you were talking about increased lending standards or loan standards, probably going to decrease the amount of loans in the economy, that has the same effect as the Fed increasing rates, which was something Powell was talking about yesterday. Do you think the Fed is on the right track here, raising rates 25 basis points? What should they be doing heading into the next meeting and thinking about that?
KENNETH ROGOFF: Oh, well, let's face it, this was as soft a hike as they could do. That's why the markets are reacting favorably. They could have either paused and said we're probably going to hike next time. And instead, he hiked and kind of signaled that, if things are still unstable in the banking system, they're probably going to pause next time. So I mean, on the whole, the market saw this, I think, positively.
I don't know if they're right because core inflation is still strong and the US economy still hasn't gone into recession yet. It might well. So it's very hard to know what's next. I thought Powell actually played it really well, you know, being transparent but, you know, quite honestly saying he didn't quite know where it was going next.
- I'd have to agree with you. I think Chairman Powell has finally gotten the knack of these press conferences here. Not too many big surprises. All right, really appreciate your insights. Thank you, Professor Rogoff here for joining us today.