In Need of Animal Spirits

From Wayne Strout, The Mystery of Sustained Low Interest Rates:

Insuring the safety of bank deposits by requiring banks to buy government debt tends to produce low interest rates but it does not encourage any expansion in business activity. Increased savings by the public increases bank deposits and ramps up the requirement for banks to hold even more government debt.

To reverse this trend, given the current regulations, the public will need to borrow more and save less. Borrowing more is unlikely because again, consistent with a well intentioned goal of financial stability, lending standards have been tightened. Saving less is also unlikely because people are so uncertain about the future... on one hand, the government has been stimulating the economy…but on another hand it has been implementing policies to restrict credit…policies that restrain economic expansion.

Unless we see a substantial increase in "animal spirits" leading to both increased borrowing (hopefully for productive activity) and/or decreased savings, it is very possible that we will have low interest rates for a long time. (Animal spirits is an economic term referring to people's willingness to take risks because of an expected future economic boom.) Of course, in such a low interest rate scenario, without such "animal spirits" we will have many banks where most of the depositor's money is simply lent to the government. This is a recipe for economic stagnation.

Rising interest rates will only occur because of increased supply of interest payments (more borrowing) from borrowers and/or decreased demand for them (less lending/saving). (This is a bit counter-intuitive as popular opinion seems to assume that interest rates are low because banks are not lending. Interest rates are low because demand for interest payments from the largest borrowers, namely governments, is increasing.) 

Keep in mind, more borrowing might be not because of "animal spirits" and increased productive activity, but rather because of increased borrowing by governments. Given the current situation with Social Security and Medicare, that is a distinct possibility.

The Nattering One muses...  After decades of economic emasculation our infrastructure has become decrepit and we are in dire need of "animal spirits."  

The reticence to raise capital investment has left US companies with the oldest plants and equipment in almost 60 years. In 2013, the average age of fixed assets reached 22 years, the highest level since 1956.

US public investment is at its lowest level since 1947. Jason Furman, chairman of Mr Obama’s council of economic advisers, "We are proposing a very large increase and that’s because the country is not investing enough in its infrastructure and it’s not investing enough in R&D.”

A very valid point and distinct possibility: more borrowing due to increasing government debt levels and not due to "animal spirits", could suppress interest rates and cause stagflation for years to come.