The U.S. Federal Reserve slashed interest rates to near zero during the Great Recession in 2008 and has kept them at historic lows ever since. The goal has been to pump money into the economy to boost growth. While lower rates have provided some benefits, there is debate about whether this monetary policy has also created distortions that could lead to future risks.
On the positive side, low rates have stimulated economic activity by making money cheaper and more abundant. With the Fed benchmark rate under 1%, corporations and households have been able to access credit and financing at very low cost. This has fueled business investment, housing demand, consumer spending, and higher stock prices – all supporting growth.
In addition, low rates have meant the U.S. government can service its enormous debt more cheaply, freeing up resources for spending in other areas. Low mortgage rates have allowed millions of Americans to purchase homes. And consumers have benefitted from easier access to low-cost auto loans and credit cards.
However, there are concerns that too much cheap money for too long can lead to market distortions. With low yields on savings and safe assets like bonds, investors are pushed into riskier bets to achieve acceptable returns – increasing speculation. We likely saw this in the 2000s housing bubble. Today, some observers warn of inflated values in stocks, bonds, and cryptocurrencies.
Prolonged easy money policy may also encourage imprudent borrowing as consumers and businesses lose their sensitivity to cost and risk. U.S. corporate debt has surged back near pre-crisis levels, particularly riskier high-yield debt. Consumer borrowing has also spiked back up. And critics argue much of this borrowing is going toward unproductive uses rather than new business investment and job creation.
At the same time, low rates strain the budgets of savers, pension funds, banks, and insurers that rely on bond investment income. Their reduced spending and investment drags on growth. Banks also generate less profit from lending in a low rate environment.
Finally, some economists caution that years of ultra-low rates leaves the Fed with little ammunition to stimulate the economy during the next downturn. Historically, the Fed funds rate has been cut around 5 percentage points in recessions, but today it only sits at 2.5%. There is limited scope left to provide stimulus with rate cuts.
In summary, while low interest rates have delivered some economic benefits, an extended period of easy money policy may also lead to excessive borrowing, inflated asset values, and capital misallocation. It also reduces the Fed’s options to provide stimulus during future recessions and crises. As the U.S. expansion continues, Fed policymakers face tough decisions around when and how fast to normalize policy without derailing growth. Getting this balance right will be key to engineering a soft landing rather than a hard one.