Fed vice chair outlines factors for continued low interest rates

Slower trend economic growth, an aging population and demographic developments, and relatively weak investment are three key factors keeping interest rates low, Federal Reserve Board Vice Chairman Stanley Fischer said today.

Addressing a conference in Rio de Janeiro, Brazil, Fischer also said concern about low rates stems from three areas: risk of falling into a “liquidity trap” (a situation where the nominal interest rate is stuck above the rate necessary to bring the economy back to potential); the potential to hurt financial stability as investors seek higher yields for profitability, and; the transmittal of a “powerful signal that the growth potential of the economy may be limited.”

The Fed vice chairman said that a “prime culprit” of slow growth has been the slow rate of labor productivity growth. Fischer pointed out that labor productivity has increased only 0.5%, on average, over the past five years. In the period of 1976 to 2005, labor productivity posted a 2% growth rate, Fischer said.

Regarding demographics, he said an aging work force – which tends to save more as it nears retirement, in anticipation of running down savings once retirement has come – could be pushing down the federal funds rate by as much as 75 basis points relative to its level in the 1980s.

On weak investment, Fischer first pointed to elevated political and economic uncertainty. “For one, uncertainty about the outlook for government policy in health care, regulation, taxes, and trade can cause firms to delay projects until the policy environment clarifies,” he said.

The solution to low interest rates, Fischer said, is rooted in both monetary policy and in “effective fiscal and regulatory measures,” which he said is true both in the U.S. and around the globe.

Vice Chairman Stanley Fischer: The Low Level of Global Real Interest Rates