Should-read: Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M.Taylor: The rate of return on everything, 1870–2015

Should-Read: Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, AND Alan M.Taylor􏰀: The Rate of Return on Everything, 1870–2015: “This paper answers fundamental questions that have preoccupied modern economic thought since the 18th century…

…What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles….

On risky returns… residential real estate and equities have shown very similar and high real total gains, on average about 7% per year. Housing outperformed equity before WW2. Since WW2, equities have outperformed housing on average, but only at the cost of much higher volatility and higher synchronicity with the business cycle. The observation that housing returns are similar to equity returns, yet considerably less volatile, is puzzling…. Before WW2, the real returns on housing and equities (and safe assets) followed remarkably similar trajectories. After WW2 this was no longer the case, and across countries equities then experienced more frequent and correlated booms and busts…. One could add yet another layer to this discussion, this time by considering international diversification. It is not just that housing returns seem to be higher on a rough, risk-adjusted basis. It is that, while equity returns have become increasingly correlated across countries over time (specially since WW2), housing returns have remained uncorrelated….

On safe returns… the real safe asset return has been very volatile over the long-run, more so than one might expect, and oftentimes even more volatile than real risky returns…. Viewed from a long-run perspective, it may be fair to characterize the real safe rate as normally fluctuating around the levels that we see today, so that today’s level is not so unusual. Consequently, we think the puzzle may well be why was the safe rate so high in the mid-1980s rather than why has it declined ever since…..

On the risk premium… the risk premium has been volatile…. Our data uncover substantial swings in the risk premium at lower frequencies that sometimes endured for decades, and which far exceed the amplitudes of business-cycle swings. In most peacetime eras this premium has been stable at about 4%–5%. But risk premiums stayed curiously and persistently high from the 1950s to the 1970s, persisting long after the conclusion of WW2. However, there is no visible long-run trend, and mean reversion appears strong. Curiously, the bursts of the risk premium in the wartime and interwar years were mostly a phenomenon of collapsing safe rates rather than dramatic spikes in risky rates. In fact, the risky rate has often been smoother and more stable than safe rates, averaging about 6%–8% across all eras….

On returns minus growth… “r ≫ g”… The only exceptions to that rule happen in very special periods: the years in or right around wartime. In peacetime, r has always been much greater than g. In the pre-WW2 period, this gap was on average 5% per annum (excluding WW1). As of today, this gap is still quite large, in the range of 3%–4%, and it narrowed to 2% during the 1970s oil crises before widening in the years leading up to the Global Financial Crisis. However, one puzzle that emerges from our analysis is that while “r minus g” fluctuates over time, it does not seem to do so systematically with the growth rate of the economy. This feature of the data poses a conundrum for the battling views of factor income, distribution, and substitution…

April 16, 2018


Brad DeLong
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