True or False?
The correct answer is false. Whether bonds are a worse investment than they used to be is a matter of opinion. One must have an opinion about two things---first, the portion of the fall in interest rates that was due to a fall in the expected rate of inflation, and second, the future real interest rate on bonds relative to the real interest rate that will be earned on stocks and other investments. Nominal interest rates on bonds tell us nothing about real interest rates on bonds and, of course, nothing about the real returns from holding stocks and other alternative assets to bonds.
Recall Equations 1 and 2.
1. i = r + τe
2. i = rr + τ
where τe is the annual rate of inflation expected during the term of the loan, τ is the actual rate of inflation, r is the contracted real interest rate, rr is the realized real interest rate and i is the nominal interest rate. Nominal interest rates indeed fell during the late 1980s in most countries, as did inflation rates. This was shown in Topic 6 of Lesson 1.
But what about real interest rates? Some calculations are necessary to determine if realized real interest rates have fallen---simply subtract the actual inflation rate from observed nominal interest rates. Even if realized real interest rates have fallen, however, bonds are not necessarily a bad investment. What counts is the "expected" future rate of inflation, not past actual rates. Depending on your expectations about future inflation, bonds could be a good investment. It would also depend, of course, on what you expect to be the returns on alternative investment opportunities.