Understanding long term interest rates movements over the austerity period and today

The first section explains some basic ideas, and those familiar with arbitrage and the natural real rate of interest can skip to the austerity section. Basics Longer term interest rates, rates on borrowing for a number of years, are what helps determine the cost of government debt, the cost of long term borrowing by firms and the cost of mortgages. A lot of popular discussion links these longer term rates to the short term interest rate set by central banks. The reason is arbitrage. Someone who buys a longer term asset with a fixed return over five years, say, could instead hold that money in a variable rate account, and arbitrage means that rates will move until lenders are indifferent between the two, so longer term rates and short rates are linked. By that logic, interest rates on a 5 year bond, say, are just equal to expectations about how the central bank will set short term interest rates over the next five years. It’s not that simple because of liquidity and uncertainty. Having…