How low can official interest rates go?

Slowing economic growth and falling inflation is leading to record low interest rates? Interest rates are being cut aggressively around the world as economic growth slows and as price inflation either falls back from recent peaks or is set to fall sharply in the months ahead. A worsening of the credit crisis since the failure of Lehman Brothers two months ago, has noticeably hit expectations for growth and inflation.

Slowing economic growth and falling inflation is leading to record low interest rates? Interest rates are being cut aggressively around the world as economic growth slows and as price inflation either falls back from recent peaks or is set to fall sharply in the months ahead. A worsening of the credit crisis since the failure of Lehman Brothers two months ago, has noticeably hit expectations for growth and inflation. In many countries, prospects for price inflation are helped by the fact that wage inflation is well-behaved, meaning that it is well below price inflation. How low can interest rates go in some of the major economies? One starting point is the approach used in the so-called "Taylor rule", which calculates the extent to which inflation and growth deviate from their long run averages, subtracts this from long run real interest rates and then adds expected inflation to get an estimate of what the short term official interest rate should be. We have calculated these rates for the US, UK and eurozone. What do they show? The answer is that overall they show that interest rates in the advanced economies have a further 1 to 2 percentage points to fall.

 

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