Monday, December 14, 2015

Low Interest Rates In The US And Britain Are The Real Normal

This article provides a graph which tells a story about interest rates that is surprising.  The low interest rates that we see today are really the norm during most of our history over the last 200 years.  The real abnormality occurred in the 70's and 80's when interest rates averaged 7.3%.  They were elevated during that period because of high inflation.  Inflation rates determine interest rates because lenders don't want to lend money out a low rate if they believe that the money will buy less in the future because of price inflation. 

The Fed and other central banks have a target inflation rate of 2%.  They have been unable to hit the target rate for many years.  We may be in for a period of low inflation and continuing low interest rates.  That would be more consistent with most of our history.  Inflation rates typically rise when the demand for products and services exceed the supply.  Most of the global economy is stuck in a period of low demand.  We don't have shortages of critical resources such as labor and sources of energy.  The dynamics that might cause global demand to grow rapidly and produce inflation are poorly understood.  Economists have been wrong about anticipated inflation since the onset of the financial crisis.

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