## What to do When Low-for-Long Interest Rates are Lower and for Longer _IMF Blog, December 14, 2020_ ## Source details **Canonical URL:** [What to do When Low-for-Long Interest Rates are Lower and for Longer](https://www.imf.org/en/blogs/articles/2020/12/14/what-to-do-when-low-for-long-interest-rates-are-lower-and-for-longer) ## Other formats - [Markdown version](/en/blogs/articles/2020/12/14/what-to-do-when-low-for-long-interest-rates-are-lower-and-for-longer/index.md) - [Structured JSON version](/en/blogs/articles/2020/12/14/what-to-do-when-low-for-long-interest-rates-are-lower-and-for-longer/index.json) - [Bundle manifest](/en/blogs/articles/2020/12/14/what-to-do-when-low-for-long-interest-rates-are-lower-and-for-longer/bundle-manifest.json) ## Bibliographic details - Authors: Tobias Adrian - Published: December 14, 2020 --- ### Context and key messages - Author: Tobias Adrian - Date: December 14, 2020 - Central banks have been pivotal in easing financial conditions in response to the COVID-19 shock and helped avert a catastrophic downturn. - More monetary stimulus will be needed to support economic recovery; central banks are implementing innovative new strategies to provide it. - Policymakers must weigh the pros of more stimulus today against the cons of higher financial stability risks in the future. - A model is presented to quantify the tradeoff between near-term support and increased vulnerability tomorrow. ### New strategies for a lower-for-longer environment - Pre-pandemic challenges: - Central banks struggled to boost economic activity and bring inflation to target even after the Global Financial Crisis. - A sharp decline in the neutral rate of interest reduced scope to counter low inflationary pressures. - Even with very low yields out the yield curve, inflation remained chronically low and appeared to be pulling down long-run inflation expectations in many economies, putting downward pressure on nominal yields and eroding policy space. - COVID-19 intensified these challenges: - Employment collapsed, threatening a major humanitarian crisis in many economies. - Inflation was further depressed by weak activity and falling commodity prices. - Policy rates have been pushed to zero or below; very low yields on long-term government bonds limit scope for stimulus via purchases of these instruments. - Recent institutional responses: - Central banks are conducting monetary policy framework reviews to identify new ways to boost employment and inflation. - The Federal Reserve adopted a “make-up” strategy to allow inflation to overshoot its target to make up for past shortfalls, aiming to better anchor inflation expectations and create optimism today that fuels a stronger recovery. ### Financial stability tradeoffs and the risk-taking channel - Unconventional policies under consideration: - More aggressive use of sovereign bond and corporate debt purchases, combined with new approaches, can speed recovery from COVID-19 and future shocks. - Risks: - Even more accommodative policies may encourage excessive risk-taking and a build-up of vulnerabilities that pose substantial future risks. - Role of macroprudential policy: - Ideally, macroprudential policies should be the first line of defense against financial stability risks, consistent with Fund policy advice. - In practice, macroprudential tools may fall short due to lack of tools for nonbank financial institutions or implementation hurdles tied to the political process. - Modeling the tradeoff: - A “New Keynesian” modeling framework is presented that incorporates a risk-taking mechanism: - Easy monetary policy stimulates aggregate demand through standard channels and by relaxing financial conditions via risk-taking. - Looser monetary policy reduces near-term risks to output and financial stability but causes financial fragilities to grow over time, increasing output risk in the medium term. - The framework helps policymakers balance the intertemporal tradeoff associated with “low-for-long” monetary policies, including those deployed in response to COVID-19. - Cross-border considerations: - Monetary policy easing by major central banks can affect financial stability in foreign economies through increased risk-taking and a buildup of leverage. - The IMF’s integrated policy framework—considering macroprudential policies, capital flow management tools, and foreign exchange intervention—can be constructive in assessing mitigation strategies. ### Policy implications and recommendations - Continue bold and innovative strategies to provide additional firepower to support faster global recovery and achieve inflation targets. - Incorporate macro-financial stability considerations explicitly into monetary policy decision making, alongside output, unemployment, and inflation objectives. - Actively deploy macroprudential tools where possible to contain financial stability risks, enabling more prolonged monetary accommodation and promoting faster recovery. - Be vigilant in managing the future financial-stability consequences of accommodative policies and make those future consequences a key part of present decision making. - Consider international spillover effects and use an integrated policy toolkit to mitigate cross-border financial stability risks. *Source: IMF Blog post by Tobias Adrian, December 14, 2020. The IMF is an organization of 191 countries.* --- ## References - [new paper](https://www.imf.org/en/Publications/Departmental-Papers-Policy-Papers/Issues/2020/11/23/Low-for-Long-and-Risk-Taking-49733) - [central banks were struggling to boost economic activity and bring inflation to target](https://www.imf.org/en/News/Articles/2020/11/24/sp112420-new-policy-frameworks-for-a-lower-for-longer-world) - [New Policy Frameworks for a “Lower-for-Longer” World](https://www.imf.org/en/News/Seminars/Conferences/2020/11/24/new-policy-frameworks-for-a-lower-for-longer-world) - [consistent with Fund policy advice](https://www.imf.org/en/Publications/Policy-Papers/Issues/2016/12/31/Monetary-Policy-and-Financial-Stability-PP4982) - [integrated policy framework](https://blogs.imf.org/2020/12/09/navigating-capital-flows-an-integrated-approach/) _Source: https://www.imf.org/en/blogs/articles/2020/12/14/what-to-do-when-low-for-long-interest-rates-are-lower-and-for-longer_