The Causes and Challenges of Low Interest Rates: Insights from Basic Principles and Recent Literature

Abstract

Real risk-free interest rates in major developed economies have declined significantly since the 1980s. This paper explores the causes of this downward trend and its challenges for monetary policy by drawing insights from both basic principles of interest rate determination and latest research. The literature suggests that the decline is likely an outcome of multiple technological, social, and economic factors including diminished productivity growth, changing demographics, elevated tail risk concerns, time-varying convenience yields of safe assets, increased global demand for safe assets, rising wealth and income inequality, falling relative price of capital, and accommodative monetary policies. I discuss merits and limitations of explanations based on these factors, and emphasize the importance of a better understanding of economic forces driving diverging trends of corporate investment and saving behaviors. I also review the implications of the Neo-Fisherism and the fiscal theory of price level for monetary policy in a low interest rate environment.

Keywords: interest rate, safe asset, tail risk, secular stagnation, monetary policy, zero lower bound

JEL Classification: E43, E52, G12, G31