Bubbles and demographics: Is China following Japan and the US?
Author: Kazumasa Iwata, ESRI, Tokyo
In 2005, former Federal Reserve Chairman Greenspan noticed the insensitivity of long-term interest rates to changes in short-term interest rates, and called it the ‘conundrum of the long-term interest rate’. His successor Ben Bernanke shed light on this puzzle by pointing out that the balance between saving and investment shifted towards a tendency to excess saving after the Asian Currency Crisis in 1997-98, despite the boom in the world economy after the IT bubble burst. High growth combined with low real long-term interest rates created the macro-economic circumstances that were conducive to the emergence of economic bubbles.
This gave rise to a controversy between the US and Chinese governments on the cause of sequential bubbles. The then Treasury Secretary Paulson pointed out that to the extent that the capital inflow from China contributed to lowering the nominal long-term interest rate in the US, China had joined the process of generating bubbles. The Chinese government blamed the US for its irresponsibility in allocating the flow of funds available to US investors. Chairman Bernanke admitted in April that the US should have used capital flow from abroad in a more productive way. If we look at the movement of the US long-term real interest rates (the interest rate on ten-year government bonds minus the rate of change in consumer prices, we see that it peaked out in the mid-1980s, and then declined gradually until 2008.