Loose money, high rates: interest rate spreads in historical perspective

Over the past fifty years interest rate spreads have widened substantially, both between longer and shorter maturity loans and between loans to riskier and less risky borrowers. In much of economic theory, the determination of interest rate spreads is analytically distinct from the determination of the overall level of interest rates. But from a Keynesian perspective that regards interest as fundamentally the price of liquidity, there is no conceptual basis for picking out the difference in yield between money and a short-term government bond as “the” interest rate; there are many other pairs of asset yields the difference between which is determined on the same principles, and may have equivalent economic significance. In this article, we argue that this Keynesian perspective is particularly useful in explaining the secular rise in interest rate spreads since the 1980s, and that both conventional expectations and stronger liquidity preference appear to have played a role. The rise in the term and credit premiums is important for policy, because they mean that the low policy rates in recent periods of expansionary policy have not been reliably translated into low rates for private borrowers.