Why Are Interest Rates So Low?

Why are interest rates so persistently low? Is it due to the effect of monetary policy and the efforts of central banks to stimulate economic recovery? Is it the result of too much liquidity sloshing around the world economy as an after effect of the world economic crisis? Is it the declining rate of inflation that has followed the widespread use of inflation targeting by central banks? Whatever is causing the downward trend in interest rates and the yields on other assets, is it a temporary development or the harbinger of a very different sort of financial future?

Interest rates in the 29 economies that make up 90 percent of the world’s GDP are low because—and to the extent that—these economies are experiencing a dearth of borrowers and hence a relatively high saver-to-borrower ratio; The dearth of borrowers has removed the power of monetary policy to increase the inflation rate in many countries because the potency of monetary policy as currently operated is derived from loan growth in the banking system; The Japanese deflation experience has been badly misdiagnosed because the standard model used in the diagnosis does not work in Japanese demographic circumstances; The world’s largest economies are rapidly approaching Japan-like demographics—and the deflationary implications of that situation.

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