For more than 30 years, interest rates have been on a downward trend because of disinflation, the changing balance of savings and investment, and slower potential growth. Although ultra-loose monetary policies prevented the crisis turning into a depression and supported activity, as well as removing the threat of deflation and a breakup of the eurozone, there is disagreement about how effective they are, and about possible undesirable effects at the current phase of the cycle. They are not the only game in town, which raises the question of other policies that could raise potential growth.
Monetary policies have become, and remain, extremely loose, including in countries where economies have been recovering for several years and are approaching full employment. The Fed has proved reluctant to normalise monetary policy. In past decades, the authorities used to raise rates well before the unemployment rate fell to a level compatible with full employment, but that is no longer the case. The UK authorities have not yet started the process. That seems partly the result of the slow pace of recovery, which is normal after a recession triggered by a financial crisis (Reinhart et al, 2014).
Official interest rates are therefore at historically low levels. That is true in the UK, Japan and the eurozone, where the refi rate has been cut to zero and the deposit facility rate has been -0.4% in March 2016. It is also true in countries like Switzerland, Denmark and Sweden, which have been forerunners for negative interest-rate policies (NIRPs). Although the Fed started to normalise monetary policy in December 2015, US official rates remain close to their all-time lows.
Long-term interest rates have also fallen to extremely low levels, and are negative up to 8 years for German government bonds (Bunds) and up to 10 years for Japanese government bonds (JGBs). Half of the bond market in OECD countries is showing negative yields. Real long yields have also fallen (see charts 3-6 below) to levels that have in the past only ever been seen in very specific circumstances, i.e. in the decade following World War II, during "financial repression" (when rates were capped and other regulations were introduced to push down rates, aimed in particular at reducing interest rates on public debt) and during the "great inflation" of the 1970s.
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by Philippe D'ARVISENET