Courtesy Reuters

The New Normal

By David Robinson

Martin Feldstein (“The Fed’s Unconventional Monetary Policy,” May/June 2016) warns that the Federal Reserve’s unprecedented quantitative easing has created substantial risks for the global economy. He argues that “once interest rates return to normal,” investors will realize that they have overpaid for assets, such as commercial real estate, and another crash may be on the horizon.

Yet interest rates may remain low for years. Since 2008, U.S. government debt has grown from under 40 percent of gdp to nearly 80 percent, a ratio that in a closed economy would crowd out other borrowing and cause interest rates to rise. But the United States is by no means a closed economy. U.S. trading partners have been more than willing to purchase U.S. government debt at low interest rates. Indeed, interest rates are lower than they’ve been for a century.

Because foreign investors hold more than one-third of U.S. government debt, it has not crowded out private domestic investment. As a result, interest rates have not risen.

The Federal Reserve may have little discretion to raise rates in the medium term, while other countries are offering negative interest rates. Although the Fed’s mandates are price stability and full employment, the Fed is unlikely to ignore the effect of any rise in interest rates on the strength of the dollar. Even a small rise in the Fed’s interest rates would strengthen the dollar and worsen the United States’ export position.

Lastly, the United States has enormous sums of capital—some $24 trillion— held in pension funds. Although many state and local pension funds are woe- fully underfunded, they nonetheless have trillions of dollars invested in stocks and bonds. In a world awash in capital, sustained low rates of return may be the new normal. 

DAVID ROBINSON is a Senior Lecturer at the Haas School of Business, University of California, Berkeley.