Real Interest Rates: Past and Future

Abstract

Before 1914 long-term price stability was confidently expected in the UK. The typical yield then of 3 per cent per annum on long-term UK government bonds can be compared with the 4 per cent per annum on government index-linked bonds at end-1992. Inflation has made conventional long-term Government bonds riskier, and it is estimated that the real expected yield on these was about 5 per cent per annum at end-1992. Estimates are also provided for years in between, and for expected real returns on equities, and for the US, and these may surprise some. As estimated, expected real long-term UK government conventional bond yields were mostly at or above 4 per cent per annum. As bonds became relatively more risky, the risk premium on equities came down and is currently quite small, so that the cost of equity capital has not risen as has the cost of government conventional bond borrowing. In the absence o f a prolonged world depression, it seems likely that current expected real long-term interest rates will not fall, and could go higher.