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Could Ultra-Low Interest Rates Be Contractionary?

Although low interest rates have traditionally been viewed as positive for economic growth because they encourage businesses to invest in enhancing productivity, this may not be the case. Instead, extremely low rates may lead to slower growth by increasing market concentration and thus weakening firms' incentive to boost productivity.

CHICAGO – The real (inflation-adjusted) yield on ten-year US treasuries is currently zero, and has been extremely low for most of the past eight years. Outside of the United States, meanwhile, 40% of investment-grade bonds have negative nominal yields. And most recently, the European Central Bank further reduced its deposit rate to -0.5% as part of a new package of economic stimulus measures for the eurozone.

Low interest rates have traditionally been viewed as positive for economic growth. But our recent research suggests that this may not be the case. Instead, extremely low interest rates may lead to slower growth by increasing market concentration. If this argument is correct, it implies that reducing interest rates further will not save the global economy from stagnation.

The traditional view holds that when long-term rates fall, the net present value of future cash flows increases, making it more attractive for firms to invest in productivity-enhancing technologies. Low interest rates therefore have an expansionary effect on the economy through stronger productivity growth.

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