(Bloomberg) — The International Monetary Fund lined up against former US Treasury Secretary Lawrence Summers in the debate over where interest rates will gravitate to once inflation is beaten.
In its latest World Economic Report, the IMF argued that rates in the US and other industrial countries will revert toward the ultra-low levels that prevailed prior to the pandemic, driven by aging populations and sluggish productivity growth. It sees the so-called natural or neutral rate – the inflation-adjusted short-term rate that neither pushes the economy ahead nor pulls it back – comfortably below 1% in the US in the coming decades.
That contrasts with the stance taken by Summers, who suggested last month that the real neutral interest rate — or R* in economists’ parlance — might be in a range of 1.5% to 2% going forward, in part because of stepped-up government borrowing to finance increased military outlays and the transition to a greener economy.
Where rates settle over time has widespread ramifications for everything from stock and housing markets to monetary and fiscal policy. Higher rates would raise borrowing costs for home buyers and governments and lessen the attractiveness of owning shares as opposed to bonds.
The IMF said the lower rates it envisions will make it easier for some countries to handle elevated government debt levels coming out of the pandemic.
Many though will still have to act to rein in budget deficits to stabilize or reduce outstanding borrowings as a share of gross domestic product, it said. For advanced economies, spending cuts are more likely to lower debt ratios than increasing government revenues, according to the global lending institution.
The Fund’s estimate of the US neutral rate is basically in line with that of Federal Reserve policymakers, who implicitly peg it at a half percentage point, according to median long-run projections contained in their quarterly economic forecasts.
The low level of neutral rates will limit the ability of the Fed and other central banks to stimulate their economies going forward, the IMF said.
“The effective lower bound on interest rates may become binding again” as monetary policymakers are forced to cut rates to about zero to handle future economic downturns, it said.
The IMF allowed that some factors might push up natural rates, though that’s not its base case. It said the short-to-medium term impact of a transition to net zero carbon emissions was unclear, depending in part how its financed.
It forecast that natural rates in emerging market economies will converge toward the lower levels in industrial countries as their populations age.
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