The role of interest rates—short- or long-term, nominal or real—is pervasive in modern economies. Changes in interest rates affect: the value of wealth accumulated by savers, their propensity to save, the financing cost for borrowers, the evaluation of investment projects, the sustainability of fiscal debt, the stance of monetary policy. And the list could go on.
We know that in many advanced economies, short- and long-term nominal interest rates are at historically low levels. And they have been very low for several years by now.
This environment should not be viewed merely as a consequence of the central banks' reaction to the global financial crisis; in a longer time perspective, it is also the end point of a trend. Some data: since the early 1990s the 10-year nominal yields on Government bonds have declined by 10 percentage points in the UK, 9 in the euro area, 6 in the US and Japan; short-term nominal interest rates have followed a similar pattern though with a larger volatility.
How come? What are the associated risks and policy changes?
In trying to answer these questions let me first recall that the nominal interest rate can be viewed as the sum of three components: 1) the real interest rate, 2) the expected inflation, and 3) a term premium.