In the US, the yield on 10-year Treasury bonds is near
all-time lows, with the same being true in the euro area, the
UK, and Japan. Yields have also declined in many emerging
markets, with interest rates falling almost 400 basis points in
Korea since the financial crisis and by a similar amount in
Israel. The decline has been less apparent in Brazil and South
Africa, though interest rates in both countries remain well
below previous peaks.
I will address two questions: Why are interest rates so low?
And why has the decline in interest rates been so
Global Real Interest Rates Have
Lower inflation explains a portion of the decline in nominal
interest rates. Longer-term interest rates reflect market
participants' expectations of future inflation as well as the
expected path of real, or inflation-adjusted, interest rates.
And while lower realised inflation and credible central back
inflation targets have likely stabilised expected inflation at
relatively low levels compared with much of the 20th century,
inflation-adjusted yields have also notably decreased.
The decline in interest rates also does not appear to be
primarily an outcome of the economic cycle. Longer-term
interest rates in the US have remained low even as the Federal
Open Market Committee (FOMC) has increased the short-term
federal funds rate by 100 basis points and as the unemployment
rate has declined below the median of FOMC participants'
assessments of its longer-run normal level.
Rather, it appears as though much of the decline has
occurred in the equilibrium level of the real interest
rate–also known as the natural rate of interest or,
alternatively, r*. Knut Wicksell, in his 1898 treatise
Interest and Prices, wrote, "There is a certain level
of the average rate of interest which is such that the general
level of prices has no tendency to move either upwards or
downwards."2 In recent years, the coincidence of low
inflation and low interest rates suggests that the natural rate
of interest is likely very low today.
Wicksell was clearly referring to the natural rate as the
real interest rate when the economy is at full employment. The
widely cited methodology of my Federal Reserve colleagues
Thomas Laubach and John Williams, attempts to gauge the natural
rate in the longer run after various shorter-term influences,
including the business cycle, have played out. In a recent
update of their analysis, they find that the natural rate of
interest has declined about 150 basis points in the US since
the financial crisis and is currently about 50 basis points. We
must remember, however, that r* is a function and not a
constant, and its estimation is subject to a number of
assumptions, the modification of which can lead to a wide range
In an extension of this analysis, the decline in the natural
rate of interest is a common feature across a number of foreign
economies.4 The fall in equilibrium interest rates
was most pronounced at the time of the financial crisis, but
rates have shown little tendency to increase during the long
recovery from the crisis.
How Should We Think about the Decline in
Equilibrium Interest Rates? An Investment and Savings
There are many factors that could be holding down interest
rates, some of which could fade over time, including the
effects of quantitative easing in the US and abroad and a
heightened demand for safe assets affecting yields on
advanced-economy government securities. I will focus on some of
the more enduring factors that could potentially lower the
equilibrium interest for some time.
In attempting to explain why real interest rates have
fallen, a useful starting point is to think of the natural
interest rate as the price that equilibrates the economy's
supply of saving with the demand for investment in the long
run, when the economy is at full employment. With this
framework in mind, low interest rates reflect factors that
increase saving, depress investment demand, or both.
Focusing initially on the US, I will look at three
interrelated factors that are likely contributing to low
interest rates: slower trend economic growth, an aging
population and demographic developments, and relatively weak
investment. I will then discuss global developments and
spillovers between countries.
But first I would like to interject a quick word on why we
as policymakers might be concerned about low interest rates. I
highlight three main worries. First, as John Maynard Keynes
discussed in the concluding chapters of The
General Theory of Employment, Interest and Money, a
low equilibrium interest rate increases the risks of falling
into a liquidity trap, a situation where the nominal interest
rate is stuck, by an effective lower bound, above the rate
necessary to bring the economy back to potential.5
Relatedly, but more broadly, low equilibrium interest rates are
a key pillar of the secular stagnation hypothesis, which Larry
Summers has carried forward during the past few
years.6 Second, a low natural rate could potentially
hurt financial stability if it leads investors to reach for
yield or hurts financial firms' profitability. And,
third–and perhaps most troubling–a low
equilibrium rate sends a powerful signal that the growth
potential of the economy may be limited.7
Slow trend growth
One factor contributing to low equilibrium interest rates in
the US has been a slowdown in the pace of potential, or trend,
growth. According to the Congressional Budget Office (CBO),
real potential growth in the US is currently around 1.5%,
compared with a pace about double that, on average, in the two
decades leading up to the financial crisis. A prime culprit in
the growth slowdown has been the slow rate of labour
productivity growth, which has increased only 0.5%, on average,
over the past five years, compared with a 2% growth rate over
the period from 1976 to 2005.8 A declining rate of
labour force growth has also worked to push down trend growth.
The CBO is projecting that the potential labour force in the US
will grow at about 0.5% per year over the next decade, less
than half the pace observed, on average, in the two decades
before the financial crisis.
Slower growth can both boost saving and depress investment.
As households revise down their expectations for future income
growth, they become less likely to borrow and more likely to
save. Likewise, slower growth diminishes the number of business
opportunities that can be profitably undertaken, weighing on
The aging of the population can work to lower the
equilibrium interest rate beyond its effect on the size of the
labour force and trend growth. As households near retirement,
they tend to save more, anticipating having to run down their
savings after they leave the labour force. Federal Reserve
economists, in one study, estimate that higher saving by
near-retirement households could be pushing down the longer-run
equilibrium federal funds rate relative to its level in the
1980s by as much as 75 basis points.9
Another factor weighing on equilibrium real interest rates
has been the recent weakness of investment. What explains the
tepid response of capital spending to historically low interest
rates? As mentioned earlier, low productivity growth has
certainly been a contributing factor, as firms see fewer
profitable investment opportunities. But elevated uncertainty,
both political and economic, has likely also played a role. For
one, uncertainty about the outlook for government policy in
health care, regulation, taxes, and trade can cause firms to
delay projects until the policy environment clarifies.
Firms also seem quite uncertain about the disruptive
capacity of new technologies. Technological developments appear
to be rapidly reshaping entire industries – in retail,
transportation, and communications. Elevated uncertainty about
the continued viability of long-standing business models could
be weighing on investment decisions. Relatedly, it is possible
that as the economy evolves in response to new technologies,
production is becoming less capital intensive than it was in
Another possible explanation for the weakness of investment
in the US has been a decrease in competition within industries,
as evidenced by decreasing firm entry and exit rates as well as
increased industry concentration.11 Less competition
allows firms to maintain high profits while lowering the
pressure on them to increase production to maintain market
In an earlier discussion, I attempted to quantify the effect
that these factors – slow growth, demographics, and
investment – might be having on the long-run
equilibrium rate in the US.12 According to
simulations from the Board's FRB/US model, the slowdown in
growth appears likely to be the primary factor depressing the
long-run equilibrium rate, although the contributions from
demographics and weak investment demand were also sizable.
Global Links: Why Has the Decline in
Interest Rates Been So Widespread?
Up until now, I have looked primarily at factors within the
US. However, as I have pointed out earlier, the decline in
interest rates is a global phenomenon. Why has the decline in
interest rates been so widespread?
One important reason is that many of the same factors that
have been driving down the equilibrium interest rate in the US
have operated with equal or even greater force in many foreign
economies. The slowdown in labour productivity growth has been
widespread across many countries. Likewise, the advanced
economies and some emerging markets have experienced
demographic shifts that are in some cases much more pronounced
than in the US, with the working-age population in some
countries even declining over the past decade.
Another explanation is that we live in an integrated global
economy where economic developments in one country spill over
into other countries via trade and capital flows as well as
prices, including interest rates and exchange
rates.13 In the most general sense, these spillovers
are captured in the pattern of current balances. If we abstract
from a somewhat sizable statistical discrepancy, the sum of
global current accounts should be equal to zero, as, in the
aggregate, one country's deficit must be matched by a surplus
in some configuration of other countries – but it is
not always apparent who is spilling over onto whom.
Current Account Balances and Global
Prior to the financial crisis, it was widely speculated that
foreign developments were depressing US interest rates. Former
Chairman Bernanke characterised the foreign forces acting on US
interest rates as the "global saving glut," with particular
reference to emerging market economies that were running
persistent current account surpluses, sometimes as a result of
specific policy decisions regarding exchange rates, reserve
accumulation, and fiscal policy.14 The global saving
glut was also a factor in the "Greenspan conundrum," or the
observation that a series of Federal Reserve rate hikes over
the period from 2004 to 2006 seemed to have little effect on
longer-term interest rates in the US. The deterioration of the
US deficit in the early 2000s was matched by growing surpluses
in the emerging markets, particularly in emerging Asia and
China as well as OPEC. The explosive growth of the US current
account deficit from 2001 to 2006, coincident with falling
interest rates both in the US and globally, supports the notion
that higher foreign saving relative to foreign investment was
likely holding down US interest rates at the time.
What can the distribution of global current accounts tell us
about international spillovers in the post-crisis era? The most
notable development has been the almost exact reversal of the
expansion of the US current account deficit observed during the
time of the global saving glut. Has the global saving glut of
the mid-2000s faded away? Falling interest rates over the
period that the US deficit narrowed suggest not.15
If a shrinking supply of foreign saving, the reversal of the
global saving glut, was behind the narrowing of the US deficit,
then the tendency would have been for equilibrium real interest
rates to have increased.16 Rather, falling
equilibrium rates suggest that falling US demand for foreign
savings has precipitated the narrowing of the US current
account deficit. US demand likely decreased for the reasons
discussed earlier, including slowing growth, demographics, and
weak investment demand.
Does the marked narrowing of the US current account deficit
post-crisis suggest that the US has been the primary source of
downward pressure on global interest rates over the past
decade? Certainly, if the US had maintained its previous
deficit, interest rates would likely be higher around the
world. However, the financial crisis revealed that the US
capacity to absorb global savings at the pace observed prior to
the crisis was unsustainable.17 Rather, an
alternative explanation would be that the sharp decline in
global interest rates post-crisis reflects factors that were
likely well in train before the financial crisis. The downward
trend in interest rates would have been more pronounced earlier
in the decade had not elevated, and ultimately unsustainable,
borrowing in the US slowed the decline in interest rates in the
years immediately preceding the crisis. This narrative is
consistent with empirical evidence that suggests that the
slowdowns in global productivity growth and labour force
growth, both key factors in the slowing pace of global growth
and the downward pressure on interest rates, predate the global
It is notable that the euro area has also seen a sizable
increase in its current account position post-crisis,
suggesting that developments in Europe have also played a role
in pushing down interest rates. The increase in the euro-area
current account in part reflects sharp reversals in the current
account deficits of Greece, Portugal, Spain, and Ireland
– all countries that had witnessed large increases in
their deficits during the global saving glut period prior to
the crisis, in a pattern similar to that experienced by the US.
However, the euro-area increase also reflects increased
surpluses in Germany and the Netherlands, countries that were
already in considerable surplus during the pre-crisis
What, If Anything, Can Be Done about Low Interest
Given the potential risks around low interest rates I
discussed earlier, including the impact on the effectiveness of
monetary policy and financial stability concerns, what should
policymakers do to address the problem?
Monetary policy has a role to play. Transparent and sound
monetary policy can boost confidence in the stability of the
growth outlook, an outcome that can in turn alleviate
precautionary demand for savings and encourage investment,
pushing up the equilibrium interest rate.
However, as I have said before – and Ben Bernanke
before me – "Monetary policy is not a
panacea."19 Also, to repeat myself, policies to
boost productivity growth and the longer-run potential of the
economy are more likely to be found in effective fiscal and
regulatory measures than in central bank actions. This
statement is true not only in the US, but also around the
globe. But it is not to say that monetary policy is irrelevant
to the growth rate of the economy.
This article has been adapted from a speech given by
Governor Stanley Fischer at a conference to
celebrate Arminio Fraga's 60 years in Brazil, July 31 2017. The
full original text with accompanying graphs can be freely
accessed at: www.federalreserve.gov
- I am grateful to Joseph W Gruber of the Federal Reserve
Board for his assistance. Views expressed in this
presentation are my own and not necessarily those of the
Federal Reserve Board or the Federal Open Market
- Wicksell's Interest and Prices, published in
German in 1898 as Geldzins und Güterpreise by
Gustav Fischer (Jena), was first published in English in
1936–see Wicksell (1936).
- See Laubach and Williams (2003). See also Gagnon,
Johannsen, and Lopez-Salido (2016) and Johannsen and Mertens
(2016). It is important to point out that r* is not an
observable variable and that estimates generally reflect
assumptions about how the economy works and should be
modelled. As such, different methodologies or underlying
economic models can come up with a wide range of estimates of
r*. Lewis and Vazquez-Grande (2017) examine parameter
uncertainty and alternative specifications in the estimation
of the natural rate of interest. Under some specifications,
they find an estimated r* at the end of 2016 of close to 2%,
far higher than the about 0.5% reported by the methodology of
Holston, Laubach, and Williams (forthcoming).
- See Holston, Laubach, and Williams (forthcoming).
- In chapter 23, p. 353, Keynes includes an interesting
discussion of the "strange, unduly neglected prophet Silvio
Gesell (1862-1930), whose work contains flashes of deep
insight and who only just failed to reach down to the essence
of the matter." He adds that Gesell was a successful German
merchant in Buenos Aires. See Keynes (1936).
- See Summers (2014, 2015, 2016).
- See Fischer (2016a) for a fuller discussion of the risks
associated with a low equilibrium interest rate.
- See Irwin (2017) for an examination of an alternative
pattern of causality, where slow growth–and, in
particular, weak wage growth–has led to low
productivity growth rather than vice versa. I should also
remind the reader of Herbert Stein's observation that the
difference between a growth rate of 1% and a growth rate of
2% is 100%.
- See Gagnon, Johannsen, and Lopez-Salido (2016), figure
12, p. 45.
- See Hilsenrath and Davis (2016).
- See Gutiérrez and Philippon (2017) and
Döttling, Gutiérrez, and Philippon (2017).
- See Fischer (2016b).
- See Clarida (2017) for a model-based discussion of global
factors and neutral interest rates.
- See Bernanke (2005).
- While it is unsurprising that interest rates fell sharply
during the recession that followed the financial crisis, it
is less apparent that equilibrium rates should have fallen so
sharply or remain so low almost a decade later following the
cyclical recovery in the US and many other countries.
- See Bernanke (2015) for a discussion of the persistence
of the global saving glut.
- This is not to suggest that the global saving glut was
the only factor leading to the financial crisis. Rather,
excessive risk-taking on the part of US households and
financial firms, along with structural defects in the
structure of regulation and failures in supervision on the
part of government regulators, also played a role.
- See Fernald (2015) and Fernald and others (2017).
- See Bernanke (2012).