Fed Signals a 9% Possibility of Returning to Zero Interest Rates

The Federal Reserve can’t rule out the possibility of its key lending rate dipping back to zero in the future, as highlighted by a team of researchers from the New York Fed led by President John Williams.

A blog entry published on July 7 revealed a 9% chance that the federal funds rate could reach what’s known as the zero lower bound (ZLB) within seven years. This risk is largely fueled by heightened uncertainty surrounding interest rates.

“Current data suggests that anticipated future interest rates are higher than those seen in recent years,” stated williams and his co-authors. “However, concerns about ZLB remain substantial over both medium and long-term periods, akin to levels noted back in 2018 due to ongoing uncertainty.”

Their analysis utilized interest-rate derivatives linked to forecasts for essential short-term rates like the secured Overnight Financing Rate, which closely tracks movements of the fed funds rate.

(Federal Reserve via Bloomberg)

The research also indicated a mere 1% likelihood that rates would hit zero within two years.

The Fed initially slashed rates into a range between zero and 0.25% back in December 2008 during the Great Financial Crisis as part of an effort to invigorate economic activity. They remained at this level for seven years before dropping again following COVID-19’s onset in 2020.

This situation has sparked debates among policymakers and economists regarding whether recent inflation spikes post-COVID might signal an end to monetary policy operating under ZLB constraints. For instance, some experts argue that emerging markets may face different challenges compared to developed economies when it comes to managing inflation without reverting back into low-rate territory.

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