Will the neutral rate of interest rates go up? Minneapolis Fed research thinks not…

Are higher interest rates here to stay?

The Minneapolis Fed research analysts argue that the fundamental forces keeping neutral interest rates low in the long run remain.

Some of the highlights:

  • Rising Interest Rates: Central banks globally have increased interest rates significantly over the past 18 months to combat inflation spurred by the pandemic and the war in Ukraine.
  • Predictions of Persistent High Rates: Notable economists, including Lawrence Summers and Kenneth Rogoff, suggest that higher interest rates may persist, contrasting with the previous decade’s average.

Federal Open Market Committee’s (FOMC) Outlook

  • Shift Towards Higher Norm: The FOMC’s projections indicate a shift towards accepting a somewhat higher interest rate as the new norm, with a notable dispersion in long-run interest rate expectations.
  • Uncertainty in Projections: The varying forecasts reflect uncertainty about long-term interest rates, influenced by post-pandemic economic recovery and global economic changes.

Fundamental Factors Influencing Interest Rates

  • The Role of R-star: The equilibrium neutral interest rate, or R-star, is crucial for understanding the balance between full employment and target inflation rates.
  • Decline in R-star: Consensus suggests a significant decline in real R-star from the 1960s to 2020, attributed to lower productivity growth and demographic changes.

Productivity Growth and Demographics

  • Productivity Trends: Despite recent advancements in AI, productivity growth has remained low, mirroring trends since the 1960s.
  • Demographic Shifts: Aging populations and declining growth rates, particularly in advanced economies, exert downward pressure on interest rates.

Impact of National Debt

  • Debt Levels and Interest Rates: While higher national debt levels traditionally suggest higher interest rates, the demand for U.S. debt as a safe asset globally may mitigate this effect.
  • Long-term Sustainability: Concerns remain about the U.S. maintaining its status as the preferred safe asset, especially with projections showing increasing debt-to-GDP ratios.

Concluding Insights

  • Future of Interest Rates: While some factors suggest higher interest rates could persist, the underlying causes of the long-term decline in neutral interest rates, such as demographic shifts and productivity trends, remain influential.
  • Uncertainty Remains: Predicting future interest rates is inherently uncertain, with potential global events capable of significantly altering the economic landscape.

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This article was written by Greg Michalowski at www.forexlive.com. Source