Low rate conundrum: the policy significance of today's low interest rates.

• Author: Berry, John M.

In almost every developed country, interest rates are extremely low by historical standards, so low that briefly this summer yields on U.S. Treasury ten-year notes reached the lowest point ever, 1.32 percent. In Germany, yields are even much lower, actually negative for maturities out to fifteen years, and in Switzerland for up to half a century!

At the short end of the yield curve, none of the major central banks, save the Federal Reserve, is contemplating raising its target for overnight rates, typically not much above zero, because the outlook for economic growth is so dismal. And the Fed is hesitant to do so because even in this country the economy is hardly surging ahead, while inflation remains below the Fed's 2 percent target.

Rates fell, of course, in the wake of the financial crisis that began in 2007, nearly a decade ago. And many analysts believe they may remain depressed for many years to come. That prospect has ramifications for many aspects of the world's economy. First and foremost, it signals that very slow economic growth is expected to continue, and that central banks have little ammunition with which to fight a renewed recession.

Harvard economist and former Treasury secretary Lawrence H. Summers, in his blog, called that all-time low in U.S. ten-year rates "a remarkable financial moment." Indeed it was.

"I believe that these developments all reflect a growing awareness of the importance of the secular stagnation risks that I have highlighted over the last several years," Summers said. "There is a growing sense that the world is demand-short--that the real interest rates necessary to equate investment and saving at full employment are very low and may be often unattainable given the bounds on nominal interest rate reductions.

"The result is very low long-term real rates, sluggish growth expectations, concerns about the ability even over the fairly long term to get inflation to average 2 percent, and a sense that the Fed and the world's major central banks will not be able to normalize financial conditions in the foreseeable future."

After the Fed lowered its target for overnight interest rates effectively to zero and the sluggish economy still needed a boost, the central bank turned to so-called quantitative easing, or QE. It began to purchase longer-term Treasury securities with the intent of lowering longer-term interest rates and encouraging investors to move into other types of assets. While QE did help, its impact was limited, even Fed officials agree.

As Summers says, persistently low rates also suggest that real returns on equities and bonds will be lower in coming years than they have been in the recent past; that businesses may have less incentive to invest and thus will likely achieve smaller productivity gains; and that overall...