Abstract: This article compares the Keynesian, neoclassical and Austrian explanations for low interest rates and sluggish growth. From a Keynesian and neoclassical perspective, low interest rates are attributed to aging societies, which save more for the future (global savings glut). Low growth is linked to slowing population growth and a declining marginal efficiency of investment as well as to declining fixed capital investment due to digitalization (secular stagnation). In contrast, from the perspective of Austrian business cycle theory, interest rates were decreased step by step by central banks to stimulate growth. This paralyzed investment and lowered growth in the long term. This study shows that the ability of banks to extend credit ex nihilo and the requirement of time to produce capital goods invalidates the permanent IS identity assumed in the Keynesian theory. Furthermore, it is found that there is no empirical evidence for the hypotheses of a global savings glut and secular stagnation. Instead, low growth can be explained by the emergence of quasi “soft budget constraints” as a result of low interest rates, which reduce the incentive for banks and enterprises to strive for efficiency.
JEL Classification: E12, E14, E32, E43
Thomas Mayer (Thomas.mayer@fvsag.com) is the founding director of the Flossbach von Storch Research Institute, Cologne, Germany. Gunther Schnabl (schabl@wifa.uni-leipzig.de) is a professor of international economics and economic policy in the department of economics at Leipzig University, Germany.
INTRODUCTION
Since the 1980s, slower economic growth in the industrial countries has been accompanied by lower interest rates, with real interest rates turning negative more recently (figure 1). The fight against the economic consequences of the severe corona crisis has triggered an even stronger monetary expansion, with even more government bond yields falling into negative territory. At the same time, investment, productivity growth, and economic growth have continued to slow. Although to some observers the pivotal role of central banks in ever-lower levels of interest is evident, representatives of central banks have stressed structural factors as the reasons for low interest rates (Lane 2019, Schnabel 2020).
Figure 1. Nominal and Real Short-Term Interest Rates in the US, Japan, and Germany
Source: IMF. Arithmetic mean. Real interest rates calculated based on official consumer price inflation statistics with hedonic price measurement.
Different schools of thought have provided different theoretical and empirical explanations. Based on Keynes (1936) and Hansen (1939), Bernanke (2005) and Summers (2014) have attributed secularly declining real interest rates to a global savings glut driven by aging societies, a declining demand for fixed capital investment, and a declining marginal efficiency of fixed capital investment (Gordon 2012). Łukasz and Summers (2019) argue that “the neutral real rate for the industrial world has trended downward for the last generation and this is best understood in terms of changes in private sector saving and investment propensities.” According to their view, central banks are simply adjusting to the exogenous forces of secular stagnation when they set the interest rate at or below zero.
In contrast, from the point of view of Austrian economic theory in the tradition of Mises (1912) and Hayek (1931), human beings strive to achieve their goals earlier rather than later and thus have a “positive time preference.” This makes negative interest rates under free market conditions impossible (Mises [1949] 1998). This view is in line with the finding of Homer and Sylla (2005) that through most of economic history real interest rates were positive. In this spirit, based on the monetary overinvestment theories of Mises (1912) and Hayek (1931) and in line with Borio and White (2004) and White (2006), Schnabl (2019) has argued that the gradual decline of interest rates in the industrialized countries has been due to asymmetric monetary policies: strong interest rate cuts during crises were not followed by respective increases during the postcrisis recovery.
The question of whether the gradual decline of real and nominal interest rates in the industrialized countries (and the rest of the world) is due to structural change, as suggested inter alia by Summers (2014) or due to policy decisions made by central banks is crucial for the economic policy agenda. The Keynesian interpretation can be used to justify further interest rate cuts, even below zero,1 as well as fiscal expansion. In contrast, from the Austrian point of view only renouncing policies that have led to low and even negative interest rates can reanimate economic activity. This article compares the two approaches and derives policy implications.
THE KEYNESIAN AND NEOCLASSICAL INTERPRETATION OF LOW INTEREST RATES AND GROWTH
The close relationship between declining nominal and real interest rates and declining (productivity) growth is in the Keynesian and neoclassical view due to exogenous factors. Structural change leads to changes in supply and demand conditions in the capital markets, with the result that the real interest rate declines. In the spirit of Hansen (1939), Bernanke (2005) attributes a savings glut to the aging of societies. As people approach retirement age they are seen to save more for old age. When the cohort of aging people is large, in the Keynesian and neoclassical approach the aggregate supply of loanable funds and equity capital rises. At the same time, profitable investment opportunities are seen to decline, reducing the demand for loanable funds and equity capital (Summers 2014).
Savings Glut, Secular Stagnation, and the Keynesian Natural Interest Rate
Following the sharp interest rate cuts of the US Federal Reserve in response to the burst of the dot-com bubble at the beginning of the new millennium, Bernanke (2005) attributed an increase in the US current account deficit (i.e., growing net capital inflows to the US) and the decline of world interest rates to factors outside the US: “A global saving glut … helps to explain both the increase in the US current account deficit and the relatively low level of long-term real interest rates in the world today.“ Bernanke (2005) argued that aging populations in a number of industrial countries and several emerging market economies, notably China, had transformed these countries from net borrowing to being net lenders on international capital markets, with the result of increased net capital flows to the US.
According to Bernanke (2005), East Asian countries prevented their exchange rates from appreciating and accumulated foreign reserves to boost the competitiveness of their exports and create war chests against balance of payments crises.2 Bernanke (2005) also observed higher US dollar earnings for oil- and raw materials–exporting countries due to rising oil prices, which were to a large extent recycled into US dollar investments. Before the subprime crisis, capital flows to the US were attracted by fast productivity growth, strong property rights, and a robust regulatory environment.
After the outbreak of the subprime crisis, which culminated in the global financial crisis of 2007–08 and prompted the Federal Reserve (and other large central banks) to cut interest rates toward zero, Summers (2014) developed a comprehensive explanation for the global decline of nominal and real interest rates from a capital market perspective. On the supply side of the capital market, Summers (2014) linked low birth rates in industrialized countries to growing savings in the tradition of Hansen (1939)3 and Bernanke (2005), who had argued that people in aging societies would save more for retirement.4 Summers associated growing income inequality with a declining marginal propensity to consume (an increasing propensity to save) in a large part of the population.5 Following Bernanke (2005), he identified accumulation of reserves in emerging market economies as a reason for the increased demand for safe assets available in the US.6
On the demand side of global capital markets, Summers (2014) linked a lower demand for fixed capital investment to changes in technology. He assumed that companies in the information and communication technology sector would have a lower demand for fixed capital. Like Bernanke (2005) and Gordon (2012), Summers (2014) argued that the potential of innovations to increase productivity had structurally declined. The resulting drop in the demand for capital goods was supposed to have been accompanied by lower prices for capital goods, leading to a further decline in investment spending in nominal terms. In Summers’s (2014) view, rising household savings drag down expected aggregate demand, including corporate investment. Thus, corporate savings rise as well.7 When savings and investments are assumed to behave in line with these “stylized facts,” the savings curve in the neoclassical capital market model shifts to the right and the investment curve to the left. The equilibrium (or natural/neutral) interest rate falls, possibly even below zero.
In the neoclassical theory it is assumed that the real interest rate is determined by the marginal productivity of capital on the demand side of the capital market and by the time preference of savers on the supply side. Thus, the market equilibrium interest rate is determined by the marginal return on capital (which drives the demand for capital) and the marginal utility of exchanging present goods against future goods (which determines the supply of capital). The equilibrium rate matching savings to investment has been called the neutral or natural rate.
The natural or neutral rate of interest is a theoretical concept and cannot be observed directly.8 A model is needed. Economists of a neoclassical persuasion have tried to derive it from the marginal product of capital of empirically estimated production functions. Those with a Keynesian preference have used Wicksell’s (1898) notion of a given interest rate prevailing in economic equilibrium to define the natural rate as the interest rate which keeps price inflation stable and output growth at its potential (see Woodford 2003).9 Thus, Laubach and Williams (2015) as well as Rachel and Summers (2019) define the natural or neutral interest rate as the real short-term interest rate consistent with the economy operating at its full potential, without upward or downward pressure on consumer price inflation. Gourinchas and Rey (2019) see a structural decline of the ratio of consumption to wealth as an indication of a decline of the natural interest rate. Following this line of thought would lead to the conclusion that rising asset prices drive down the natural interest rate.
Laubach and Williams (2015) as well as Rachel and Summers (2019) estimate the output gap via the Keynesian IS curve10 and inflation with the Phillips curve, which links price changes to the level of unemployment. As they find a negative output gap and declining (measured)11 consumer price inflation, the natural or neutral interest rate estimated with their model declines from the 1980s. The decline has accelerated since the 2007–08 global financial crisis, with the natural interest rate turning negative recently. These findings are confirmed by the estimates of Jordá and Taylor (2019), who argue that half of the decline trend is due to structural factors, such as lower productivity growth and an aging population, and the rest to central bank policy.
To derive policy implications, Laubach and Williams (2015) apply the estimated natural interest rate to the Taylor (1993) rule. The original Taylor rule assumes a real interest rate of 2 percent, which was constant and close to the long-term US growth rate of 2.2 percent observed at the time. With an assumed inflation target of 2 percent,12 this implied at the time a long-term equilibrium or nominal natural interest rate of 4 percent, consistent with inflation and output at target levels.13 Inserting their estimates of a declining natural interest rate into the Taylor rule, Laubach and Williams (2015) arrive at the policy recommendation to gradually decrease the key policy interest rate toward or even below zero. If the natural interest rate falls, the policymaker has to cut the nominal interest rate to achieve the inflation target.
The Keynesian-Neoclassical Framework
In the seminal Keynesian macroeconomic framework, consumption is determined by real income (Y), with the propensity to consume declining over time (as in Keynes 1936). Bernanke (2005) and Summers (2014) argue that the propensity to consume (propensity to save) declines (increases) when the population is aging and the working-age population is shrinking:
(equation 1) 
where C denotes real consumption, k the marginal propensity to consume, D the aging (shrinking) of the (working-age) population, and Y the real gross domestic product (GDP), with D > 0 and 
< 0.14
Real investment, I, is a function of the real interest rate, i:
(equation 2) 
Investment increases when the interest rate falls (
< 0).
The price level, P, is a function of the economy-wide capacity utilization (output gap), measured by the ratio between actual real GDP (Y) and potential real GDP (Ypot).
(equation 3) 
Prices rise when real output grows above potential 
.
Real GDP in a closed economy is the sum of consumption and investment:
(equation 4) 
Inserting (1) and (2) in (4) and solving for Y yields:
(equation 5) 
Substituting (5) into (3) gives:
(equation 6) 
In this framework, if a society is aging, the propensity to consume, k, decreases, and the price level and output fall. To compensate for this effect, a central bank pursuing an inflation target needs to decrease the real interest rate to increase investment, output, and thereby the price level again, as explained by Laubach and Williams (2015) as well as by Rachel and Summers (2019). Interest rate cuts are necessary to maintain the inflation target and an equilibrium in the goods market.
The IS model abstracts from the supply side, as potential output is assumed to be given exogenously. It can be augmented, however, by adding a neoclassical element in the form of a production function where potential output is dependent on the capital stock, K:
(equation 8) 
with the change in the capital stock being equivalent to investment (∆K = I).15 Assuming profit maximization, the marginal product of capital equals its real return, r:
(equation 9) 
An investment project would usually only be financed when the real return is expected to be larger than the real interest rate on credit (i) plus the risk premium (rp). Hence,
(equation 10) 
where rp is assumed to be constant for the sake of simplicity.
The upshot is that the propensity to consume (k) falls when the population ages, and savings increase (as S = Y – C). The resulting decline in demand and output prompts the central bank to reduce i. At the same time, as argued by Summers (2014) and Gordon (2012), investment and productivity growth decline, which lowers r.16
THE AUSTRIAN OVERINVESTMENT FRAMEWORK AND THE ROLE OF THE FINANCIAL SECTOR
The overinvestment theory of Mises (1912) and Hayek (1931) says that a credit interest rate manipulated by the central bank below the natural interest rate at first induces an economic upswing, which is fueled by credit creation of the banking sector.17 When interest rates are lifted again by the central bank to contain inflation, the upswing turns into a downswing. When interest rates then are strongly cut in response to the downswing, distorted economic structures created during the upswing are conserved, which leads to persistently low growth.
The Austrian Overinvestment Framework
According to Böhm-Bawerk (1884) and Mises (1940), the interest rate is a measure for time preference, with finitely living people assigning greater value to goods and services today than goods and services available at a future point in time.18 The borrowing of funds to produce capital goods requires the payment of interest as a compensation for the present consumption foregone on the part of the lender (agio). According to Böhm-Bawerk’s (1884) concept of roundaboutness, this positive interest rate payment is possible if the time-consuming move to a more capital-intensive production process allows higher production in the future. If a roundabout method would not result in a more productive production process, people will not engage in time-consuming roundabouts of producing the capital goods required for an increase of consumption in the future.19
Before consumer goods can be produced, capital goods have to be produced. Whereas a high interest rate is an impediment for many investment projects with a comparatively low expected return, a low interest rate stimulates investment, as the costs of roundabouts decline. A lower interest rate signals higher present savings and as a result higher consumption in the future. This provides an incentive to increase capacity for the production of consumption goods. When some enterprises start to invest in response to a lower interest rate, they need inputs from other enterprises, which extend their production capacities as well.
A cumulative upswing sets in which is financed by credit creation of banks.20 This allows real investment (I) to temporarily exceed real savings (S). Banks create additional credit to keep interest rates aligned with the central bank interest rate. In the first phase of the upswing, when less than the full labor force is in use, wages do not increase. The profits of banks and enterprises grow, which is reflected in rising stock prices.21 When unemployment has declined to a very low level, the negotiating power of labor unions strengthens and wages rise. Enterprises have to lift prices to cover their costs, which pushes up inflation. When rising inflation forces the central bank to raise interest rates, the benchmark for the profitability of past and future investment projects is raised.
Owing to higher financing costs, incomplete investment projects need to be abandoned, and new investment projects become unprofitable. A cumulative downswing evolves. During the downswing—according to the overinvestment theory—the central bank keeps the credit rate, via the central bank interest rate, above the natural interest rate, which falls as investment declines. As interest rate is kept above the natural interest rate, the downturn is aggravated. As unemployment grows, wages and prices fall. The dismantling of investment projects with low profitability and falling wages and prices are seen as prerequisites for the economic recovery. The downswing entails a cleansing effect (Schumpeter 1912), as resources can be shifted to higher return investment projects.
Transmission via the Financial Sector
In the Keynesian model the central bank steers the money market interest rate via the LM-curve by expanding the money supply.22 There are neither banks nor capital markets involved. In contrast, in the Austrian model the banking sector transmits the interest rate policy of the central bank to credit rates through credit extension of banks. Investment can increase the fixed capital stock (nonfinancial investment, e.g., machinery for producing consumer or investment goods) or financial assets.
To model the role of banks in financing investment, the relationship between nominal savings and nominal investment can be represented as
(equation 11) 
The variable Pnf denotes the price of real nonfinancial investment goods (Inf, fixed capital investment) and Pf the price for real financial investments (If) such as equities. Sn is equivalent to (nominal) savings out of existing money, ∆C is the credit (and money) creation of banks.23 We assume that Inf, If, and ∆C are all negative functions of the interest rate (i). If the interest rate falls, nonfinancial and financial investments grow and additional credit is created domestically. Savings are assumed to increase (fall), when the credit interest i increases (falls).
The prices of nonfinancial investments and financial investments are assumed to depend positively on investment activity. If more is invested, the prices of the real and financial investment goods rise:
(equation 12) 
with 
(equation 13) 
with 
If the credit interest rate (i) declines, savings decrease. Nonfinancial investment and financial investment increase, with the additional demand for funding covered by domestic bank credit creation (∆C > 0). The presence of banks allows the funding of nonfinancial and financial investment not only from existing savings but also from credit (i.e., new money) created by the banks. Nominal investment can temporarily be higher than saving:
(equation 14) 
During the upswing nonfinancial investment grows, as low interest rates set by central banks signal higher present savings and thereby higher future consumption (Mises 1912; Hayek 1931). Resources are redirected from the production of consumer goods to the production of capital goods.24 Alternatively, financial investment increases. As deposit rates are low, consumers have an incentive to withdraw deposits from banks and buy stocks of enterprises and banks, whose profits increase during the upswing. If equity prices are expected to rise further, speculation may set in, with the valuation of equities becoming delinked from their fundamentals. A credit boom evolves, with prices of nonfinancial and financial investment rising. The speculative boom may also attract additional funds from abroad, as observed during the 2003–07 US subprime boom and the boom in the southern European countries during the same time period.
When rising wages force enterprises to lift prices, a central bank targeting goods price inflation is forced to increase the interest rate. At higher interest rates nonfinancial and financial investments with comparatively low expected returns become unprofitable and need to be abandoned. As the central bank keeps the interest rate high during the downswing, the commercial banks tighten credit (∆C < 0). Nonfinancial and financial investments have to be abandoned, and their prices fall. In the resulting recession, unemployment rises.
If central banks change interest rates in an asymmetric way—i.e., interest rates are cut more during the recession than they are lifted during the recovery from the crisis to prevent unemployment25 —interest rates will gradually decline toward zero, as shown in figure 1. The average productivity of investment will also be affected: while during the upswing financial and nonfinancial investments with comparatively low marginal productivity are realized, these investment projects are not scrapped in the downswing. The average productivity of investments declines, and growth weakens.
EMPIRICAL EVIDENCE
In both the Keynesian/neoclassical and the Austrian models, the natural or neutral interest rate is a theoretical concept which cannot be observed directly in reality. Empirical estimates of the natural interest rate, as discussed earlier, are only as reliable as the underlying model is an appropriate representation of reality. Any specification errors would be captured by the interest rate derived from the model. The Keynesian model does not model the banking sector and ignores credit (or money) creation by banks. Furthermore, the Phillips curve, relating the output gap to inflation, on which the Keynesian model relies, has flattened and become unstable in most industrialized countries.26
Global Savings Glut, Aging Societies, and Increasing Inequality
A core argument of the secular stagnation hypothesis is that interest rates have been driven down by aging societies, in which people save more for retirement (section 2). This would imply that low birth rates in the industrial countries and China would go along with growing household savings rates.
To provide empirical evidence for the savings glut hypothesis, Demary and Voigtländer (2018) create an econometric model estimating real interest rate developments in twenty-four Organisation for Economic Co-operation and Development (OECD) countries with proxies for the savings glut (life expectancy, old-age dependency, young-age dependency) and secular stagnation hypotheses (total factor productivity growth, labor force growth). In contrast to the secular stagnation hypotheses, total factor productivity growth has no statistically significant effect on real interest rates in their estimates. In contrast to the savings glut hypothesis, both the old- and young-age dependency ratios have a statistically significant negative influence on real interest rates.27
Empirically the link between aging populations and household savings rates is weak. The most prominent example is Japan, where since the 1980s the fast aging of the society has come along with declining household savings rates. Figure 2 shows that together with the short-term interest rate, which has been pushed down by the Bank of Japan to zero, household net savings as a percentage of GDP and as percentage of disposable income has declined as well. Latsos (2019) shows empirically that the main determinant of Japanese household savings rates has been the declining interest rate set by the Bank of Japan, with interest rate cuts constituting an incentive to save less. This is in stark contrast to the aging population hypothesis of Bernanke (2005), Summers (2014), and Weizsäcker (2014).
Figure 2. Household Saving Rate and Short-Term Interest Rate in Japan
Source: OECD, IMF, Bank of Japan.
A broader sample of OECD countries also shows no robust evidence of a correlation between aging populations and growing household savings rates. Figure 3 shows the change in the old-age dependency ratios of several OECD countries28 since 1995 on the x axis, calculated by subtracting the old-age dependency ratio in 1995 from the old-age dependency ratio in 2018. A positive value indicates an aging population. The populations of all the OECD countries in the sample have aged according to this measure. Japan stands out as a particularly fast-aging country. The y axis shows the difference in the household savings rate between 2018 and 1995 in percentage points. A negative (positive) value indicates a declining (increasing) household savings rate since 1995. Based on this measure, the majority of the countries experienced a decline in the household savings rate. The aging-society-savings-glut hypothesis would imply a close positive relationship between the two indicators in form of an upward-trending line moving from left to right. But there is no correlation at all.
Instead of household savings rates, enterprise savings rates have increased in some industrialized countries such as Germany and Japan (figure 4). This has been due to three reasons. First, interest rate cuts have reduced the financing costs of enterprises, which traditionally have been borrowers in capital markets. Lower interest expenses have raised retained earnings. Second, for the enterprises of export-oriented economies, such as Japan and Germany, depreciation of the domestic currencies caused by strong monetary expansions has generated windfall profits. Third, fixed capital investment as percent of GDP has tended to decline. This could be explained, in the tradition of Hansen (1939), by slowing population growth (Summers 2014) and slowing technological innovation (Gordon 2012). More likely, however, enterprises expected lower demand owing to downward pressure on real wages because of relaxed interest rate constraints (see below).
Figure 3. Old-Age Dependency and Household Savings Rates in OECD Countries, 1995–2018
Source: OECD. Changes in household savings rates as a percent of GDP.
Finally, Summers (2014) argues that increased income inequality reduces (increases) the propensity to consume (save). However, growing income and wealth inequality may not be driven by “the laws of capitalism” (as, for instance, suggested by Piketty 2014), but by expansionary monetary policies (see Duarte and Schnabl 2018). The redistributive effects of persistently loose monetary policies have several dimensions.
One important transmission channel for growing wealth inequality is asset prices, which ultraloose monetary policies drive up, since assets are disproportionately held by wealthier people. In contrast, the interest rates on bank deposits, which are the preferred saving vehicle of the middle- and lower-income classes, are depressed in real terms into negative territory. Growing income inequality can also arise from the negative impact of persistently loose monetary policy on real wages, as will be explained below.
Figure 4. Net Corporate Lending in the US, Japan, Germany, and China
Source: OECD. Corporate net lending is equivalent to enterprises’ net savings minus net investment, plus net capital transfers, minus acquisitions less disposals of nonfinancial nonproduced assets.
Constant Marginal Efficiency of Investment in Industrialized Countries
The neoclassical extension of the IS model by Gordon (2012) assumes that the marginal productivity of capital has declined, possibly into negative territory. Figure 5 shows that this hypothesis cannot be supported empirically for industrialized countries such as the US, Japan, and Germany. The marginal productivity of capital, defined according to equation (9) as the ratio of absolute change in real GDP to real investment, is largely constant in the US, Japan, and Germany.29
Apart from the cyclical downturn during the global financial crisis in 2008–09, the marginal productivity has remained positive and fairly stable around 10 percent. This implies that gradual interest rate cuts and increasing money creation by the large central banks in the industrialized countries have not boosted real nonfinancial investment to an extent that would lower the marginal productivity of real capital. This is consistent with the fact, that—together with slowing output growth—fixed capital investment as a percent of GDP has tended to decline, in particular in industrial countries such as Japan and Germany (see figure 6).
Figure 5. Marginal Productivity of Capital of the US, Japan, China, and Germany
Source: AMECO. Marginal productivity of capital is defined as the absolute change in real output compared to the previous year divided by real investment of the current year.
Since the turn of the millennium—driven by capital inflows from the industrialized countries—the capital stock has expanded very fast in China (figure 6) and other East Asian countries (Schnabl 2019b). Chinese investment (as a percent of GDP) increased far beyond that in the industrialized countries.30 At the same time, as shown in figure 5, the marginal productivity of capital in China has declined substantially since the early 1990s.
Moreover, the gradual decline of interest rates seems to have boosted real financial investment in the industrialized countries, with financial markets expanding. New asset classes, such as asset-backed securities, were created, and new countries, such as a number of emerging market economies, joined the international capital markets. Also, asset prices strongly increased, as shown in figure 7. Since the late 1980s, the arithmetic mean of equity and real estate prices in the US, Japan, and Germany has—with fluctuations—increased strongly relative to consumer prices. With asset prices being inflated, the marginal productivity of financial investment seems to have declined, indicated, for instance, by increasing price-to-rent ratios in many real estate markets.
Figure 6. Fixed Capital Investment as a Percentage of GDP
Source: IMF.
The inverse relationship between low interest rates (associated with a high degree of new money creation by central banks) and asset prices can be illustrated with the Gordon (1959) growth model of equity valuation, which relates the price-earnings ratio of enterprises to the interest rate. A simple version of this model can be written as
(15) 
where SP denotes the equity price per share, E earnings per share, g expected nominal earnings growth, and k the discount rate, representing the financing costs of the enterprise. The secular stagnation hypothesis suggests that the price-earnings ratio of equities should have been largely unaffected by the decline in interest rates, as expected earnings growth should have declined in parallel to fading growth dynamics. Thus, the relationship between stock prices and earnings should have remained stable. On the other hand, if the interest rate decreases exogenously and expected earnings growth remains widely unchanged, the price-earnings ratio rises.
Figure 7. Consumer, Stock, and Real Estate Prices in the US, Germany, and Japan
Source: IMF. Arithmetic mean.
The rise of the price-earnings ratios since the start of the global asymmetric monetary policies in the second half of the 1980s is consistent with a decline in interest rates relative to the growth of expected earnings. The US S&P 500 Shiller cyclically adjusted price-earnings ratio has increased sharply on trend since the late 1980s (figure 8). It reached a peak in the year 2000 and has remained far above the level of the 1980s. A similarly strong expansion occurred in the second half of the 1920s before the black Friday in September 1929, which triggered the Great Depression. It seems that central banks pursing point inflation targets31 during a period when, inter alia, global factors have depressed inflation have not only pushed real interest rates in credit and capital markets to ever-lower levels, but have also boosted asset prices to record highs.32
Figure 8. US S&P 500 Shiller Cyclically Adjusted Price-Earnings Ratio
Source: Macrobond.
Increasing Debt, Declining Labor Productivity, Wage and Financial Repression
When interest rates are pushed ever lower, possibly below the growth of real income, increasing levels of debt become sustainable. It becomes more attractive for enterprises to raise their return on equity through financial leverage than through nonfinancial investment aimed at increasing productivity.33 This can be illustrated by decomposing the return to equity into profits (R), equity (E), turnover (T), and total capital (K).34
(16) 
The rate of return to equity (
) can be raised by increasing the profit margin (
