In previous articles, we saw how looking back at the history of returns on various types of investments gave us a useful perspective on rates of return. Similar insights are available from interest rate history. For example, at midyear 1997, short-term interest rates were about 5 percent and long- term rates were about 7 percent. We might ask, “Are these rates unusually high or low?” We discuss bills and bonds in detail in this series of posts. For now, it is enough to know that bills are short-term and bonds are long-term.
Probably the most striking feature is the fact that the highest interest rates in U.S. history occurred in the not-too-distant past. Rates began rising sharply in the 1970s, and then peaked at extraordinary levels in the early 1980s. They have generally declined since then. The other striking aspect of U.S. interest rate history is the very low short-term interest rates that prevailed from the 1930s to the 1960s. This was the result, in large part, of deliberate actions by the Federal Reserve Board to keep short-term rates low – a policy that ultimately proved unsustainable and even disastrous. Much was learned by the experience, however, and now the Fed is more concerned with controlling inflation.
With long-term rates close to 6 percent as this series of posts is written, many market observers have commented that these interest rate levels are extraordinarily low. Based on the history of interest rates, however, 6 percent may be low relative to the last 25 years, but it is not at all low compared to rates during the 170-year period from 1800 to 1970. Indeed, long-term rates would have to fall to 4 percent or lower to be considered low by historical standards (but don’t hold your breath).