Zero percent interest rates cause a bubble because valuations have to increase to the point where their forward-looking returns are a risk premium above bonds. When rates are zero for a long time, that means valuations go very very high. When rates come back up, valuations drop. Speculation can add further overshoot in both directions.

Are their countries with negative nominal rates without asset bubbles?

Have their been high interest rate countries with asset bubbles? E.g., dutch 1600s interest rates or 16% during Tulipmania.

> Are their countries with negative nominal rates without asset bubbles?

That's very hard to know, but to be clear it's negative real rates that drive the bubbles. There's much more incentive to speculate when cash is a hot potato. For example Japan is much less bubbly these days than in the 1980s, even though nominal interest rates are lower now.

> Have their been high interest rate countries with asset bubbles? E.g., dutch 1600s interest rates or 16% during Tulipmania.

Presumably, that's why Tulipmania was confined to tulips, instead of spreading euphoria to absolutely every asset class. Even with high rates it's absolutely possible to have local bubbles in things like tulips, beanie babies, or Dogecoin. It only takes the promise of high real returns. When real interest rates are negative, even the promise of zero real return becomes mouthwatering.

> That's very hard to know, but to be clear it's negative real rates that drive the bubbles.

Real rates are usually negative. Real interest rates defined as the Nominal Rate - Inflation. Japan has a negative nominal rate right now.

> Real rates are usually negative.

Let me put that a bit more precisely:

https://www.longtermtrends.net/real-interest-rate/

> When rates are zero for a long time, that means valuations go very very high. When rates come back up, valuations drop.

And yet people keep saying that nobody can time the market…

I'm not saying that you can time the market. It's a lot more nuanced than that.

* You don't know the long term path of interest rates. Even the Fed Chair doesn't, because they don't know what will happen with inflation. (They do know the short term timing though, which is why they're not supposed to trade.)

* Even if you're expecting a correction, you don't know when the correction will occur or by how much. It could stay aloft like Wile-E-Coyote after the fundamentals drop out, or crash early in anticipation of the fundamentals changing.

* And when it does fall, you don't know where it will land, nor how many times it will bounce along the way down.

One drives the other.

I thought that the liquidity was driven by the money multiplier and the Fed's quantitative easing. If the fed set the interest rate at 10% but put in 20 trillion dollars into the economy there'd be bubbles everywhere.

But Feds have both put trillions of dollars into the economy and kept the interest rate near zero. So I think it’s useless to argue which exactly of these moves has caused bubbles.

You're right about now. If we desire to tease these issues apart we can look at history both the US and elsewhere.

Why would they be able to put 20T$ into the economy at a 10% interest rate? Who are the counterparties? In other words, who is taking those loans in your mind?

The Fed can buy mortgage backed securities like they have done since they've started quantitative easing. The Fed has purchased Apple bonds. This is in addition to US Treasuries.

My original comment was a mechanics related comment in which liquidity (credit + cash) pushes up asset prices and not rates (although there's high correlation especially in the past 20 years in the US).

This is based on my understanding of Ray Dalio. https://www.youtube.com/watch?v=PHe0bXAIuk0

The volume of mortgage backed securities is based on the volume of loans that people take. At higher interest rates, people take out fewer and smaller loans. The Fed buying up more MBS would put downwards pressure on interest rates, which would be diametrically opposed to their goal (in your scenario) of maintaining high interest rates.

There is a correlation between liquidity and rates, but it's an inverse correlation. That's Open Market Operations 101.

Besides, if your macroeconomic goal is to reduce inflation (which is the reason for raising interest rates in the first place), one subgoal should be to reduce the volume of loans that are being issued. After all, bank-issued loans are new money, which adds to demand, which helps prop up inflation. That's Monetarism 101.

Our disagreement appears to be this. You believe that zero interest rates lead to bubbles. I believe that excess liquidity is responsible for bubbles. They frequently both happen together because that's how the Fed tries to stimulate growth and spending.

My example of the Fed with high interest rates and a lot of QE was a way to see where our disagreement would appear. It's similar to the great recession where there were interest rates lower than they are now, but because the private sector wasn't extending credit (less Cash + Credit); there didn't appear to be any asset bubbles.

The volume of mortgage backed securities is based on who can and want to get loans. During the great recession it was hard to qualify for a mortgage even though many people wanted to do so.

I appreciate you trying to get to a shared understanding. I don't have too much time, so just the short version:

> The volume of mortgage backed securities is based on who can and want to get loans. During the great recession it was hard to qualify for a mortgage even though many people wanted to do so.

"Want" is a difficult word. I want a private island, but I can't afford one. So my contribution to effective demand for private islands is zero. In the same sense, I don't think the effective demand for mortgages was particularly high during the great recession. But anyway, we agree on the observation that low interest rates and low mortgage volumes can go hand-in-hand.

One point where I think we differ is the direction of causalities in central bank behavior. My point is that central bank QE causes low interest rates (but low interest rates don't necessarily cause QE). The upshot is that while "low interest rate policy, no QE policy" is possible, "high interest rate policy + QE policy" is not possible. The two policies would be in logical conflict with each other.