In the United States and other parts of the world today, real interest rates are negative. Negative real yield environments are not unprecedented (they existed in the 1930s, 1940s, 1970s, and early 2000s — overall, about a third of the time since 1927), but they pose important challenges for spending and investment policies. Institutions typically spend around 5% of endowment assets annually, which means that they need to earn 5% after inflation if they wish to maintain current spending levels. The question is whether one can reasonably expect to earn a 5% real return with acceptable risk in today’s economic environment.

Real yields have declined significantly over the last 15 years; in particular, U.S. five-year real yields have declined from 4% to –1.3% a year. Real yields are negative when expected inflation (measured as break-even inflation) is higher than nominal Treasury bond yields. Today’s five-year real yield of –1.3% a year, for example, reflects a five-year nominal yield of 0.7% and expected inflation of 2.0% (Table 1). Only at much longer maturities are real yields positive today, although even those yields are still well below historical levels. Read more.