Global | The future of interest rates: not just in the hands of the central banks

The end of the pandemic also marked the end of more than a decade of near-zero interest rates, fueled by ample liquidity from central banks.

Key points

• Key points:
• After its end a year and a half ago, the pendulum swung to the other extreme with the Federal Reserve and the European Central Bank stepping in with the most restrictive policies of the last 40 years
• But monetary authorities do not set interest rates at will, and their actions are only mandated to control inflation. So what interest rate should we expect in the future: the current high levels or a return to pre-pandemic lows?
• At the end of the 19th century, Knut Wicksell defined the "natural rate of interest" (NIR) as that threshold at which rates exert neither inflationary nor disinflationary pressures: a monetary policy of rates higher than the NIR will cool the economy, while lower rates will overheat it.
• During the three decades prior to the pandemic, the NIR in developed countries fell steadily as a result of a strong expansion of supply (i.e., savings) coupled with a structural contraction of demand (investment). Various estimates suggest that the NIR declined from 4% to levels close to 2.5%; i.e., before COVID, rates could be expected to rise to 2.5% once the deflationary pressures of the time were under control.
• Today, rates are reaching 4% in order to quell current inflationary pressures. But can we still expect 2.5% in the long term? The pandemic has altered the supply and demand for credit, but whether these changes are structural or temporary is still a matter for debate.

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