frankel151_TIMOTHY A. CLARYAFP via Getty Images_interest rates TIMOTHY A. CLARY/AFP via Getty Images

The End of Zero Interest Rates

As recently as 2022, most monetary economists expected interest rates to remain low indefinitely. While many analysts still expect near-zero interest rates to return, they will likely remain elevated for the foreseeable future, making it harder for governments to service their debts.

CAMBRIDGE – What a difference two years make. In 2021, when interest rates were near zero in the United States and the United Kingdom and slightly negative in the eurozone and Japan, the consensus was that they would remain low indefinitely. Astonishingly, as recently as January 2022, investors put the probability of rates in the US, eurozone, and the UK rising above 4% within five years at only 12%, 4%, and 7%, respectively. After adjusting for expected inflation, real interest rates were negative and projected to stay that way.

In fact, despite the US Federal Reserve and other central banks’ aggressive monetary tightening, real interest rates remained significantly negative until late 2022. Moreover, long-term rates increased more moderately than short-term rates: by October 2022, the yield curve had inverted, signaling that financial markets were expecting central banks to reduce short-term rates in the near future. This sentiment stemmed from the widespread expectation that both the US and global economies would enter recession.

The Fed recently raised its policy rate to 5.25%. In the US and many other countries, real interest rates have also moved into positive territory. And now that the US appears to have avoided a recession after all, rates will likely stay well above zero for a while.

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Correction Aug 13, 2023 10:59UTC

The fourth and fifth paragraphs have been changed to include accurate figures for US interest rates.