The past year’s turmoil in the financial markets has prompted investors to flee to the “safety” of low-risk Treasury securities, helping to push the interest rate on Treasuries to exceptionally low levels. Adjusted for price inflation, the return on these securities has been barely positive in recent months.

Whether real interest rates are positive or negative in the future depends largely on what happens to the rate of price inflation. As the chart below shows, it was actually negative over the 12 months ended in March, which helped push real returns upward. But if it accelerates again, real returns could quickly turn negative. 

Policy makers at Federal Reserve might actually welcome a bit more price inflation—because negative real rates, by eliminating the reward for saving, will encourage people to spend instead of save, thereby (Fed officials hope) reviving consumer spending and economic growth. But this approach creates a real dilemma for investors.

This commentary is based on a longer discussion of how the current mix of government policies will affect investments in the May 18, 2009, issue of Research Reports. Also in this issue:

• A review of a new book, Money, Markets, and Sovereignty
• A discussion of a proposal that could reform banking without more regulation
• Advice on the Making Work Pay tax credit

This issue is available free to AIER subscribers or $2 for non-members.

To subscribe to AIER Research Reports, please become a Sustaining Member of AIER. Membership starts at just $39 per year.

Already a member? Keep your eye out for the May 18 issue of Research Reports hitting your mailbox soon.

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