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1 1 (March 15, 2019)

handle is hein.crs/govyiw0001 and id is 1 raw text is: Congressional a Research Service Low Interest Rates, Part 3: Potential Causes March 15, 2019 Interest rates have been unusually low by historical standards since the 2007-2009 financial crisis, as discussed in CRS Insight IN 11044, Low Interest Rates, Part 1: Economic and Fiscal Implications, by Marc Labonte. This Insight discusses various theories of why rates have been low. Nominal Versus Real Rates Part of the reason why nominal interest rates (the stated rate familiar to most people) have been low is because inflation has been low since the crisis. Because inflation erodes the value of the return to an investment, it is common to adjust interest rates for inflation. Even when this adjustment is made, the resulting real interest rates are still low by historical standards, as discussed in Part 1. The rest of this Insight focuses on explanations of why real rates have been low. Low inflation may also be affecting real rates. Investors and households may now expect that inflation will remain low in the future. If they perceive there to be less risk of future inflation, they may demand less compensation to protect against inflation risk, resulting in lower real interest rates. The fact that real rates were high in the 1980s after inflation became high permits inference that this phenomenon may now be working in reverse. Potential Causes As Part I discussed, both short-term and long-term interest rates have been low since the crisis. The Federal Reserve's monetary policy decisions are the main determinant of short-term interest rates, as discussed in CRS Insight IN 11056, Low Interest Rates, Part 2: Implications for the Federal Reserve, by Marc Labonte. If the Fed were keeping rates artificially low, however, inflation would be expected to rise, but it has not. Moreover, monetary policy has much less influence on long-term rates, suggesting some broader economic forces are at work. Economists have identified two trends in particular that could explain why rates fell to unusually low levels during the crisis. First, an increase in risk aversion caused a flight to safety-there was relatively more demand for safer assets such as Treasury securities, driving down those rates, and less demand for riskier assets with higher rates. If a higher percentage of total credit is extended to lower-risk borrowers, then average interest rates would be lower. Some have argued that new financial regulations after the Congressional Research Service https://crsreports.congress.gov IN11074 CRS INSIGHT Prepared for Members and Committees of Congress

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