As recently as 2022, most monetary economists expected interest rates to remain low indefinitely
After adjusting for expected inflation, real interest rates were negative and projected to stay that way.
The Fed recently raised its policy rate to 5.25%. In the US and many other countries, real interest rates have also moved into positive territory.
Short-term nominal interest rates are now above 5%, and real interest rates have returned to positive territory.
And now that the US appears to have avoided a recession after all, rates will likely stay well above zero for a while.
In Europe and Japan, nominal interest rates did fall slightly below zero, as low as -0.5% and -0.75%. This was the effective lower bound.
If the equilibrium real interest rate was neagtive and the effective lower bound on nominal rates was close to zero or even -0.50%, the global economy would be in serious trouble.
The responsibility for maintaining full employment would thus have to revert to fiscal policy, which is often politically fraught. This scenario is the “secular stagnation” hypothesis, popularized by former US Treasury Secretary Lawrence H. Summers in 2013.
In 2020, jointly with Jason Furman, Summers reiterated that “real interest rates are expected to remain negative.”
As recently as June 2022, former IMF Chief Economist Olivier Blanchard observed that “the long decline in safe interest rates stems from deep underlying factors that do not appear likely to reverse anytime soon.”
In 2021, both investors and economists could be forgiven for believing that equilibrium interest rates had settled close to zero for the foreseeable future. After all, short-term rates in the US had been near-zero for nine of the previous 13 years, from 2009 to 2015 and again from 2020-21.
Jeffrey Frankel Project Syndicate 13 August 2023
Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University
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