Real interest rates have tumbled around the world, from the short to the long end of the maturity spectrum. This is not a sustainable development; subnormal real rates are sparking imbalances in the global economy that can only end in tears. Yet the exit strategy holds increasing peril.
The culprit is a white-hot global liquidity cycle. Fearful of a Japanese-style post-bubble carnage, the US Federal Reserve led the way with 550 basis points (bp) of monetary easing during 2001-03. Other central banks went along for the ride. The Bank of Japan augmented its zero interest policy with extraordinary efforts at quantitative easing. Even the European Central Bank took its policy rate down to zero in real terms and allowed excess growth in Euroland M-3 above the 4.5% reference zone for the past three and a half years. And the People’s Bank of China, operating with a pegged currency, followed the Fed with a major monetary stimulus of its own – fostering M-2 growth that has averaged 16.5% since 2000.
