Fed's Fischer: Low Global Neutral Rates Cause for Worry

--Slower Growth, Aging Population, Weak Investment Behind Low R-Star

--Low Neutral Rates Threaten Effectiveness of Monetary Policy

By Jean Yung

     WASHINGTON (MNI) - The current global environment is distinguished by the

low level of global real interest rates, which have refused to rise even as

economies recovered from the financial crisis, Federal Reserve Vice Chairman

Stanley Fischer said Monday. 

     In the United States, longer-term interest rates have remained low even as

the Federal Open Market Committee has increased its benchmark interest rate by

100 basis points in the past two years and as the unemployment rate has declined

below the FOMC's forecast of full employment, Fischer said. Economists estimate

the rate at about 0.5% today.  

     Worse, it appears that secular factors led by slower economic growth, an

aging population and relatively weak investment are driving the decline, Fischer

said in remarks prepared for a conference in Brazil. 

     In turn, low neutral rates can reinforce slow growth, make monetary policy

less effective and present risks to financial stability, Fischer said.

     "A low equilibrium rate sends a powerful signal that the growth potential

of the economy may be limited," an implication Fischer called "most troubling." 

     For monetary policymakers, a low equilibrium interest rate increases the

risks of "falling into a liquidity trap, a situation where the nominal interest

rate is stuck, by an effective lower bound, above the rate necessary to bring

the economy back to potential," Fischer said. 

     It could also potentially hurt financial stability if it leads investors to

reach for yield or hurts financial firms' profitability, Fischer said. 

     Against that background, monetary policy has a role in play to address the

problem, Fischer said. "Transparent and sound monetary policy can boost

confidence in the stability of the growth outlook, an outcome that can in turn

alleviate precautionary demand for savings and encourage investment, pushing up

the equilibrium interest rate." 

     He also noted that some of the many factors holding down interest rates

could fade over time, including the effects of quantitative easing in the United

States and abroad and a heightened demand for safe assets affecting yields on

advanced-economy government securities. 

     However, it is up to fiscal policy and regulatory change to drive the

productivity rate higher to support growth. 

     R-star "is a function and not a constant," Fischer said. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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