The era of low interest rates could be over. Structural factors are currently sketching out a change in trajectory calling for long-term rates to anchor themselves at levels that were once considered “normal”. With, at the end of the day, an artificial intelligence setting the pace.
For the time being, central bank models indicate that the so-called neutral equilibrium rate — defined as being the rate compatible with production remaining at its potential level for a long time and an inflation rate remaining at the target — remains close to of its pre-pandemic values. In Canada, this rate, which is also defined as being the dividing line between expansionary and restrictive monetary policy, is currently between 2 and 3% in nominal terms.
The question arises: once inflation returns to the 2% target, will the cost of money stay at higher levels? The answer cannot come with certainty due to potential exogenous shocks that can alter the course. But two beliefs stand out. The real neutral rate is unlikely to fall below the values estimated before the pandemic. On the contrary, there is a high probability that it will increase. Moreover, it has been observed that the forces that kept long-term rates in a downward trend during the 25 years preceding the pandemic are in the process of being reversed.
Paul Beaudry, Deputy Governor at the Bank of Canada, made it the central theme of a speech delivered on June 8. “While I don’t claim to know with certainty the path of interest rates, I can point out some sources of risk. In this way, I hope I can help Canadians to be prepared if we do enter a new era of high interest rates. »
He identified four major structural factors modulating this game of balance between supply and demand, between savings and investment, which influence the level of interest rates. First, the aging of the population under the baby-boom effect, with savings growing as the retirement age approaches. “This stage of working life where saving takes place affected large proportions of the population of advanced economies, which was a source of both upward pressure on global savings and downward pressure. decline in real rates. »
Then, globalization, with the rapid rise of the Chinese economy. In many of the so-called developing countries, “savings rates have been high over the past few decades. […] These savings represented new substantial financial flows which accentuated the downward pressure on real interest rates in favor of the growth of these countries and their integration into the world economy”, continued the Deputy Governor.
Then, the rise of inequalities, which translates into an increased concentration of wealth. With a marginal propensity to consume weakening the higher the income, these “better off” therefore generally save more than the average, which adds downward pressure on interest rates.
Finally, the weakness of investments observed in the years preceding the pandemic despite the fall in interest rates.
For the foreseeable future, there are many countries where large strata of the population are now in retirement and therefore at a stage where they are drawing down on their savings, putting downward pressure on global savings and upward on real interest rates. This is also the case for China, which is showing a similar demographic change causing “a decline in the flow of savings that irrigate the global economy”.
As for the rise in inequality, “globalization is now marking time, and geopolitical tensions […] could even make it regress. This could then create less inequality in advanced economies, where globalization has generally not benefited everyone equally”.
Finally, on the lack of investment. The transition to a decarbonized economy opens new opportunities for investment in green technologies and infrastructure. “We are perhaps on the eve of a new era of public and private investment: this change could result in upward pressure on real interest rates,” underlines Paul Beaudry. Especially since the increasing number of retirements and the shortage of labor make the latter more scarce than capital.
Beyond these four big influencers, the literature also discusses shifts in fiscal policy, demand and supply for prime assets, and the relative price of investing, the speech notes read. One could add the high public debt.
Low productivity
Olli Rehn, Governor of the Bank of Finland, also addressed the topic. Among these drivers generally considered important in anchoring the equilibrium rate, he insists on the slowdown in productivity growth. While abrupt reversals of the secular neutral rate drivers are unlikely, “economies have nevertheless undergone several significant shifts. One of them concerns productivity growth”. But in his view, the green transition is likely to generate longer-term productivity gains.
Another structural change is the increased use of AI. “Because AI is a general-purpose technology, […] its potential effects on productivity can be immense. The influence of AI on the neutral rate, however, will largely depend on the reaction of the labor market, he says. “AI has the potential to displace workers across the distribution of skills and income. […] Perhaps the most significant challenge posed by AI is the potentially significant increase in inequality between workers. »