Low Rates Could Remain Stubbornly Low for Longer than Most Think

The Fed’s decision to raise short-term interest rates does not necessarily signal the beginning of a return to pre-2007 rates (averaging 7.3% from 1970-2007), writes Neil Irwin, Senior Economics Correspondent with the New York Times. Despite widespread predictions of sharply rising rates, Irwin notes that “interest rates historically are most closely tied to inflation.” Not only is the inflation rate currently very low, but most signs suggest it is likely to stay that way for some time. The Fed has been trying to increase inflation to a mere 2%, while Treasury bond prices “predict annual inflation in the United States of only 1.7 percent a year over the next three decades.” Irwin suggests: “that would imply we are in an economic era more like the late 19th century, with persistent low inflation or mild deflation, or perhaps like the 1950s, when the economy was growing but inflation was firmly in check.”  New York University economic historian Richard Sylla seems to agree: “If we keep inflation under control, maybe we’ll enter a period like the ’50s,” observing, “those were normal rates, and they were accompanied by a slight amount of inflation, 1 or 2 percent.” The interest rate on a 10-year Treasury note was less than 4% each year from 1876 to 1919 and again from 1924 to 1958. Bryan Taylor of Global Financial Data says, “we’re returning to normal, and it’s just taken time for people to realize that,” opining, “I think interest rates are going to stay low for several decades.”  As Irwin notes, markets seem to agree: “If people thought the Fed was going to raise short-term up to 5% soon, no one would lock their money up in a 10-year bond paying only 2.2 percent.” Indeed, the Fed’s target rate has been lowered from 5.25% at the onset of the financial crisis in 2007 to a long-term target of 3.5%. In any event, Irwin concludes, “whether rates will be high or low in a few years” depends mostly on “forces deep inside  the economy that are poorly understood and extremely hard to forecast,” reminding readers that “just because many people are old enough to remember the high inflation and high rates of the 1970s and 1980s doesn’t mean that is the normal to which the economy will inevitably revert.”