macroeconomics, interest-ratesInterest rates reflect the opportunity cost of capital. It is easy to see why nominal interest rates change as inflation fluctuates, but what economic explanations are there for widely fluctuating real interest rates (both through business cycles and across countries)?
In the case of treasuries, a nation needs to sell the bonds to raise capitol to fund its operation. One way a nation can spur interest in their bonds is to increase the return rate they offer for that bond. It is in the nations interest to pay the lowest possible interest rate while maintaining funding for its operations.
People(and nations) buy the bonds as an investment. The rate they are willing to buy them at depends on where they feel they can get the best return for the risk. Even in times where the risk seems really low for the treasuries if there is a better investment opportunity out there then the treasury rate will need to increase to draw enough interest to fulfill the need.
Default is not the only risk with treasuries either. The value of the currency could drop. Inflation could rise above the index used for the bond. There could be investments available that will pay a greater return. As well as countless other factors that go into a decision over which investment to make. The risks may be small but they are real risks that factored into those decisions.
Real interest rates, particularly for longer maturities, generally correspond to the market’s assessment of the minimal level of return the economy can provide with nearly zero risk. In most economies and particularly in good times, investing in pretty much anything is expected to yield some positive return, mostly due to the growth in the economy itself and increases in the aggregate wealth level over time. In troubled economies or during recessions, the expected growth of the economy may be too slow or even negative, such that a “risk-free” investment is not expected to generate returns. The long-horizon real rate of interest is primarily a reflection of expected growth in the real economy.
Supply and Demand determine interest rates:
2.) Risk and Liquidity affect Demand
3.) Central Bank Intervention: Quantitative Easing
4.) Many other factors affect the supply and demand for debt - such as psychology, opportunity cost...etc.
Changes in Debt Supply and Demand account for the fluctuation in interest rates.
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