The Corner

Monetary Policy

Ultra-Low Interest Rates: Implications and Consequences (Spoiler: Not Good)

Lawrence Summers attends the annual meeting of the World Economic Forum (WEF) in Davos, Switzerland, January 18, 2017. (Ruben Sprich/Reuters)

Somehow I don’t think that Larry Summers is expecting the Twenties to roar very loudly.


Former U.S. Treasury Secretary Larry Summers said global financial markets appear to be anticipating slow growth and low real interest rates for the next few years, which will gut the ability of central banks to guide economies.

“What markets are seeming to price is a return to secular stagnation, or Japanization,” Summers said in a lecture to the London School of Economics on Wednesday.

Calculating what markets are pricing in at any given point is not a precise science (#understatement), especially at a time when the Fed’s policies are also distorting the price of money (interest rates). Nevertheless, running through Summers’s comment is the implication that the extent of that distortion should not be overestimated. Companies do not appear to be in a hurry to put money to work, and (to oversimplify) that means money would be “cheap” anyway.


The remarks build on [Summers’s] view since 2013 that one of the chief problems in industrial nations is an excess of savings and lack of investment.

At least part of the reason for that lack of investment — as I discussed here and here — is, I suspect, that the financial crisis (and memories of the financial crisis) “scarred” managements in a way that led them to re-evaluate their perceptions of risk. If the “impossible” had happened, it could happen again. That meant that the potential return managers would have to expect before undertaking a new project would have to be higher than it would have been beforehand. The “impossible” has, of course, now returned, this time in the shape of COVID, and it too is likely to leave scars — something that, as I also mentioned before, those responsible for the original work on scarring had considered.

To quote (again) the St. Louis Fed’s Julian Kozlowski:

Perception can be everything: People observe new events and use these experiences to inform their expectations. For example, if you haven’t seen many pandemics, you think pandemics are rare. However, when you see a pandemic, you come to believe that pandemics are not as rare as you previously thought . . .

Consciously or not, we all use past events to inform our beliefs, like econometricians do. Rare events are those for which we have little data. In turn, the scarcity of data makes new rare events particularly informative, so rare events trigger larger belief revisions. Furthermore, because it will take many more observations of non-rare events to convince someone that a rare event really is unlikely, these changes in expectations are particularly persistent.

Somehow I have the suspicion that the evident reluctance of some in government to relax COVID-related restrictions will only make that scarring worse.

Whatever the causes of this depressed investment demand, Summers (Bloomberg reports) believes that it will constrain the ability of policy-makers to use increased interest rates as a way of stabilizing the economy (an increase in the price of a good for which demand is weak isn’t going to be very helpful). Summers believes, according to the report, that that task will fall to government, a worrying prospect at a time when the administration’s plans — from higher taxation to increasingly onerous regulation — seem purpose-built to discourage investment. The thought that, by default, this could be used to boost the case for increased investment by the state is not a reason for celebration.

Adding to the gloom, Summers (rightly) worries about the way that ultra-low interest rates do give a fillip to one type of investment: malinvestment.


Summers also warned that low borrowing costs will add to the risk of another financial crisis.

“Extremely low interest rates set the stage for leveraging and the perpetuation of zombie enterprises and the perpetuation of financial bubbles,” Summers, who is also a paid contributor to Bloomberg, said. “We’re seeing a lot of evidence of speculative risk. Extremely low and negative real interest rates are problematic.”

Indeed they are.


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