Tuesday, March 31, 2015

Why Are Interest Rates So Low?

Ben Bernanke's first blog after leaving his job as the Chairman of the Federal Reserve, is a response to those who criticized the Fed for keeping interest rates too low.  He presents a good description of the determinants of interest rates and what the Fed does to influence those rates.  The Fed attempts to bring interest rates as close as it can to the equilibrium interest rate consistent with full employment and its inflation target.  The market plays a dominant role in this process.  When the expected rate of return on investment is high, the demand for investment loans will be high, and that will cause interest rates to rise.  The opposite will happen when the expected return on capital investment is low.  Interest rates are low primarily because the demand for investment funds in global economy is low.  Fiscal policy also plays a role in the process.  When governments borrow to fund deficits it absorbs more of the supply of savings which tends to increase interest rates.  The Fed, and other central banks, can affect the supply of money and short term interest rates through monetary policy but its actions are limited by the expectations that business has on the expected return on capital.

The Fed struggles to determine what the equilibrium rate is at any point in the business cycle.  That is the subject of much of the debate among members of the FOMC which recommends monetary policy actions.  If it too aggressive it can accelerate price inflation which drives interest rates higher.  If it is not aggressive enough, it will not satisfy its full employment of resources goal.  The primary reason for low global interest rates is that the expected return on capital investments is low.

No comments:

Post a Comment