At the end of 2018, the Federal Reserve received strong criticism, both from investors and the president, for raising interest rates too quickly. While there has been considerable debate surrounding the Fed’s actions, what is clear, is that despite hiking interest rates nine times since 2015, the long-term trend for short-term rates is down.
Even with the recent increases to the federal funds rate – the Fed’s primary policy tool – rates are still considerably lower than they were during the peaks in the 80s, 90s, and 2000s. The trend shows that over the past four decades, Fed officials have dropped the federal funds rate more than they have been able to raise it – leading to a series of lower highs, and lower lows. And with the Fed signaling that the current cycle of rate hikes might be at an end, there seems to be no reason to think short-term rates will rise meaningfully anytime soon.
The downward trend is also witnessed in longer-term rates. While some of the recent pressure can be attributed to the Fed’s policies following the financial crisis, there are concerns that the overall decline in rates is the result of a long-term slowdown in productivity and economic growth. This is a concern globally, and many advanced economies are experiencing slow growth and low or even negative interest rates.
The Good and the Bad of Persistently Low Rates
Low interest rates, especially longer-term rates, make it more affordable for consumers to buy homes and for companies to make capital investments – two major drivers of the economy. However, from the perspective of central banks, like the Federal Reserve, low interest rates can constrain their ability to conduct monetary policy.
Typically, when the Fed wants to encourage economic activity it lowers the federal funds rate. However, with rates relatively close to zero, the Fed has very little room to drop the rate enough to stimulate the economy. Persistently low interest rates also increase the possibility of creating asset bubbles. With bond yields so low, investors are incentivized to shift money to higher yielding, but risker assets, which can lead to increased economic instability.
