Vol 12 (2015) - Issue 6

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Low Interest Rates for Longer

Main assumptions:
– Interest rates will remain low by historical standards and debt levels will remain high.

Main implications:
– No room to cut interest rates and little room to leverage up, a conundrum for policy;
– Continued modest growth and low inflation – Frequent market re-pricings.

One important legacy of the Great Recession is the combination of three reinforcing dynamics:
Loss of output, low inflation and high debt levels. Their effect lingers as the rise in the stock of debt and ensuing deleveraging period reinforce slower growth, low inflation, and low interest rates, which in turn slows down the debt reduction process. 10-year Treasury yields should rise only gradually and the 2s10s curve should remain fairly flat over our two-year forecast horizon.

Loss of output
A Geneva Report reviews thoroughly how the financial crisis depresses aggregate demand (business cycle) and aggregate supply (secular trend). The loss of output is permanent, unlike in a recession when the loss of output is temporary. However, the economy’s rate of growth may re-attain its pre-crisis pace. The worst outcome is the combination of permanent loss of output and a slowdown in the trend growth rate. That was the case for the 2008 Great Recession in Developed Markets.