Three reasons why long-term interest rates are abnormally low

Long-term interest rates on sovereign debt may be abnormally low due to: The presence of a premium that reflects the risk-free nature of the public debt 1 ; The presence of a liquidity premium, given the high liquidity of sovereign debt markets 2 ; Central banks’ fear of triggering a public debt crisis if monetary policy does not prevent long-term interest rates from rising 3 . These three mechanisms are amplified if risky asset prices become very high, if investors buy a lot of illiquid assets, and if public debt ratios are very high. 1 See for example M. Brunnermeier, S. Merkel, Y. Sannikov, “Debt as Safe Asset”, NBER Working Paper no. 29626, January 2022. 2 See for example T. Willems, J. Zettelmeyer, “Sovereign Debt Sustainability and Central Bank Credibility”, CEPR Working Paper no. 16817, December 2021. 3 M. Wolf, L. Zessner-Spitzenberg, “Fear of Hiking? Monetary Policy and Sovereign Risk”, CEPR Working Paper no. 16837, December 2021.