Why Are Interest Rates So Low?

Since the financial crisis of 2007-09, and especially in recent months, Europe and the United States have seen zero and even slightly negative short-term nominal interest rates, and sub-zero risk-free real interest rates.  In June I participated in a conference on “Zero Interest Rate Policy and Economic Order” at the University of Leipzig, organized by Gunther Schnabl (U Leipzig), Ansgar Belke (U Duisburg-Essen), and Thomas Mayer(Fossback von Storch Research Institute).  The topic faced participants with the need to make a key judgment call: Are ultralow rates the new normal, i.e. are they long-run equilibrium rates determined by market fundamentals, or are they so low because of ultra-easy monetary policies and other policies?  In Wicksell’s terminology, is the real “natural rate” currently below zero, or are central banks holding market rates below the current natural rate? We cannot directly observe the natural rate, but we can look for indirect indicators. In Wicksell’s famous and now-standard analysis, a central bank can drive (or hold) the market rate of interest below the natural rate by injecting money, which shifts the supply of loanable funds curve to the right, increasing the quantity of loanable funds and lowering the interest rate (the “liquidity effect”).  As the new money circulates it drives up prices and nominal incomes, however, which shifts the nominal demand for loanable funds curve to the right, raising the market interest rate (the ...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs