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The End of Lower for Longer: A Post-COVID Silver Lining?

Structural changes to the global economy suggest higher prices and rates ahead.

Paul Gruenwald
Global Chief Economist
S&P Global Ratings

Published: January 13, 2023


“Lower for longer” has resulted in many unwelcome distortions in recent decades, but there are reasons to think it may be coming to an end.

The COVID era highlighted the need for (i) supply chain resilience over efficiency, meaning higher costs for producing, storing and shipping goods, and (ii) a faster green transition, meaning higher interest rates as the required investment absorbs savings.

The end of this phenomenon will not be painless, but it should bring benefits.

While the COVID-19 pandemic and climate change represent large shocks to the economic system, there is a silver lining: Each in its own way will contribute to the end of “lower for longer.” This will lead to a more balanced and sustainable macroeconomic environment.

Lower for Longer: The History

The past few decades have been characterized by “lower for longer.” Inflation has generally run below central bank targets, necessitating a policy of ultralow interest rates. When the policy rate reached effective zero, quantitative easing was employed. This involved large central bank purchases of government bonds to further ease financial conditions. The main policy challenges were allowing inflation to rise while cushioning the impact of the global financial crisis and COVID-19 on the financial sector and the economy more generally.

Lower for longer was the result of several structural factors. China’s entrance into the global production and trade system, which amounted to a large, positive supply shock, put persistent downward pressure on prices. Demographic pressures from aging populations, which led to a rise in savings, put downward pressure on interest rates. The ongoing demand for safe assets by central banks and other entities put further downward pressure on rates.

Chart 1 shows the monthly combinations of policy rates and inflation for the U.S. over three decades. Both inflation and the policy rate have moved steadily lower over that period.

Chart 1

Lower for Longer: The Consequences

Persistent low rates have led to many unwelcome consequences.

  • Low rates distort asset prices. This is because future revenues are discounted at a lower rate, generating higher present values. This applies to financial assets (such as equities) as well as nonfinancial assets (such as real estate).

Low rates distort prices for both financial assets, such as equities, and nonfinancial ones, such as real estate.

  • Low rates restrict room for monetary policy maneuver. If policy rates are close to (effective) zero, then if activity slows and inflation starts to fall below target, the room to cut rates is limited. So, the necessary stimulus may not be forthcoming. The alternative is quantitative easing, which has its own side effects, such as sucking up valuable collateral (government bonds) from the financial sector.
  • Low rates keep zombie firms alive. Abnormally low rates keep so-called zombie firms in existence. These are firms that have difficulty covering their interest costs, let alone generating any profits. They tend to pull down productivity and compete for resources against more productive firms.
  • Low rates encourage the reach for yield and excessive risk-taking. Fund managers and households that promise or need to generate a minimum return on assets struggle in an abnormally low-rate environment. The response is often to purchase higher yielding but riskier assets.

The world has changed in the COVID-19 era, and lower for longer may be a thing of the past. Here are two reasons why.

Change #1. Resiliency Over Efficiency Means Higher Prices

Supply chains failed the resilience test. The COVID-19 pandemic showed that global supply chains, after having passed the efficiency test for decades, were not able to absorb the wild swings in demand and worker availability that occurred during the pandemic. The results were order backlogs, congested ports and higher prices.

As a result, supply chains are being reconsidered. They are now likely to include more redundancies, more inventories, and more nearshoring and friendshoring. The last of these reflects geopolitical considerations, which will compound the purely economic changes. Overall, these changes will lead to higher costs.

Change #2. Accelerated Green Transition Means Higher Rates

COVID-19 and the war in Ukraine accelerated green transition awareness. An indirect result of the pandemic was increased awareness of climate change — specifically, the need to transition to greener energy sources and sustainability concerns. This shift has taken place across society, involving households, investors, all types of firms, policymakers and activists.

Chart 2

Higher investment means higher interest rates. A basic tenet of economics is that savings equals investment, with the rate of interest equilibrating the two. Abundant savings push rates lower. That is what has happened in recent decades. Conversely, a rise in investment pushes interest rates higher. Therefore, a sustained rise in green — or any — investment relative to savings will lift rates on a continuing basis.

Benefits of the End of Lower for Longer

The benefits of the end of lower for longer are clear. Rates will rise from zero, lessening the need for investors to reach for yield. Savers will be better rewarded. Asset prices are likely to be valued more moderately as discount factors rise. Higher structural cost pressures will push monetary policy rates higher. And central banks will have the opportunity to unwind their balance sheets and end the associated distortion of asset prices.

Rates will rise from zero, and central banks will have the opportunity to unwind their balance sheets and end the associated distortion of asset prices.

The transition path will not be painless. Weaning the economy off low rates will have a cost. Asset price adjustment will lower wealth and some spending, as we are seeing at present. Borrowing costs will rise, forcing some buyers to delay planned large, credit-driven purchases. Debt service for floating rates debt will increase as well. Zombie firms will face a reckoning. All of these will involve some pain, but this will be more palatable if growth and employment remain strong.

Overall, we think the benefits outweigh the costs, bringing about a more balanced and sustainable macro-credit environment.

Learn more

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