Fed's Williams says historically low interest rates will persist

[WASHINGTON] Historically low interest rates are here to stay, making it much harder for central banks in wealthy countries to prevent and limit recessions in the future, according San Francisco Federal Reserve Bank President John Williams.

Writing in the bank's latest economic letter, Mr Williams argued that a decline in the long-run economic growth rate of the US and other rich nations has depressed business investment, and with it, interest rates.

A low-rate world is "likely to be very persistent," as an aging population and lagging productivity hold down growth, he said.

That's not to say that rates can't rise from current levels. In fact, Mr Williams said in an interview on Feb 3 that it might make sense for the Fed to increase borrowing costs next month given the performance of the economy.

Equilibrium Rate

In the economic letter, Mr Williams instead focused on the longer-term: the equilibrium interest rate - so-called r-star - that neither stokes nor slows the growth of the economy when it is operating at full potential.

Fed officials lowered their estimate of the long-run neutral rate to 3 per cent at the end of last year from 3.5 per cent in Dec 2015, according to their median projections released by the central bank.

The decline in the natural rate "presents significant challenges for monetary policy and financial stability," Mr Williams said.

It means that central banks will have less room to cut rates if their economies are threatened by recession and will be more dependent on other unconventional tools, he said.

"In a low r-star world, what were once called 'extraordinary' policies - like zero or negative interest rates, forward guidance, and balance sheet policies - are likely to become the norm," he wrote.

Risks to financial stability also may be greater because persistently low rates could make it harder for banks to earn profits and might encourage investors to take on greater risks in a search for higher yields, he added.

While Fed Chair Janet Yellen has also made the case for rates remaining low by historical standards, she told lawmakers last week that the neutral rate is expected to "rise somewhat over time" as some of the after-effects of the 2008-09 financial crisis fade.

BLOOMBERG