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Are declining long-term rates in our best interest?

Here are today's two questions: Why do long-term interest rates keep falling? And is the decline a good thing or something that should make us nervous?

On the surface, the drop in long-term interest rates, such as mortgage rates, is a puzzle. The Federal Reserve has been raising short-term rates steadily over the past year, the economy is in reasonably good shape, and the news on inflation has been mixed. For months, economists and money managers have been predicting that higher rates are coming. But like meteorologists who warn of storms that don't arrive, the experts keep getting the forecast wrong.

Last week the rate on a 30-year mortgage was about 5.7 percent, below the 6.3 percent it reached last June when the Fed began raising rates. No one is sure what is going on -- Fed chairman Alan Greenspan has called the drop in long rates a ''conundrum" -- but there is no lack of theories to explain the bond market's curious behavior. The explanations include:

An influx of foreign money. When investors -- foreign or domestic -- buy US Treasury bonds, the price of bonds rises and rates fall. The Chinese have been heavy buyers of our securities as a way of holding down the price of their exports to this country. When they invest in American bonds, the Chinese boost the value of the dollar relative to the yuan, their currency. Oil producing countries, flush with extra money thanks to high energy prices, have been treating the US bond market like a giant money market fund -- a place to park their cash when they don't know what else to do with it. Falling rates on bonds translate immediately into lower mortgage rates.

A lack of corporate borrowing. American companies have been earning record profits, which has sharply cut their need to issue new debt. With so little corporate debt to buy, investors have been forced to purchase Treasury bonds, further pushing down rates.

The markets anticipate a weakening economy. The evidence here is iffy. After a pause in March, the US economy appears to have regained momentum. Globally the story is a bit different. ''There is a global industrial slowdown underway," said Anirvan Banerji, research director at the Economic Cycle Research Institute, a New York forecasting firm. Slowing growth -- in Europe and China -- is keeping interest rates low around the world, Banerji said.

Inflation is under control. For my money, this is the most plausible explanation for low rates. Last week, the government reported that consumer prices rose a steep 0.5 percent in April. But virtually all the increase was the result of high energy prices. The price of commodities such as oil, steel, and building materials has soared. Other prices have not moved much at all. Neither have wages. Wages rose 2.4 percent over the past year, the smallest increase in 20 years. James Medoff says wages are what counts. Medoff is a Harvard economics professor whose specialty is labor markets. Medoff's logic is simple: Wages are a big piece of business costs. If wages are growing slowly, businesses are not under much pressure to raise prices. ''Some people think inflation is right around the corner," Medoff said. ''It is not around any corner I am looking at. Not yet, anyway."

Does it matter why rates are so low? In fact, it does. If rates are low for fundamental economic reasons -- moderate growth and low inflation -- there is nothing to worry about. But if rates are being distorted by temporary factors -- heavy foreign buying of Treasury bonds, for example -- then there is cause for concern.

The Federal Reserve is worried that artificially low long-term rates are fueling a speculative bubble in housing. Bubbles have a way of doing real damage when they pop. Think back to what happened to your 401(k) when the stock bubble burst in 2000. If the Fed gets worried enough, it could keep raising short-term rates to dampen speculation, a course of action that might lead to a sharp slowdown in the economy.

My hunch is we will be OK, and that today's low rates mostly make sense. But I'm not sure of that. If Greenspan can't explain what is going on, I don't want to be overconfident.

Charles Stein is a Globe columnist. He can be reached at stein@globe.com.

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