Causes Of Low Interest Rates, Economic Impact, And Optimal Monetary Policy

Interest rate is an important controller of economic activities and a link connecting macroeconomic and microeconomics,whose trend reflects important information about economic conditions.Since the 2008 financial crisis,a series of new economic characteristics related to interest rate have emerged in major economies around the world.First,the interest rates of major economies have continued to stay at a low level.Not only have the policy rates and government bond rates in many countries become negative,the world's real interest rate has also been declining since the 1980 s.Real interest rates in many countries have fallen to historical low levels.Second,the economic recoveries and inflations of major economies have been slow since the 2008 financial crisis,which leads to a simultaneous existence of low interest rate,low economic growth and low inflation.It means that inflation may no longer be a simple monetary phenomenon.The relationship between interest rate and macroeconomic variables becomes difficult to explain.Third,even though many central banks have adopted unprecedented expansionary monetary policies like quantitative easing and negative interest rate,their effects to stimulate economic recovery are weaker than expected and need to be re-examined.These economic phenomena have led to a series of important issues,which pose great challenges to macroeconomic theories and policy practices.From a long-term perspective,why have the interest rates of major economies continue to stay at a low level? What economic logic and underlying mechanism do those phenomena reflect?Meanwhile,why do economic growths of major economies continue to slump under low interest rate conditions? At the same time,How should we understand the relationship between interest rate and macroeconomic variable? From a short-term perspective,why is it so difficult for the unprecedented expansionary monetary policies to stimulate output and inflation? How should we view the effect of monetary policy under low interest rate conditions? What is the optimal monetary policy rule under low interest rate conditions? How to solve the low interest rate problem completely? The above issues are important and need to be explored in depth.In this context,this study analyses the cause,economic impacts and policy responses of the low interest rate problem,based on which we build a comprehensive and systematic framework.Our study provides useful implications for global economic recovery.Specifically,this study is divided into six chapters.We introduce the background,significance,methods and contributions of the research in Chapter 1.We study the reason of low interest rates in Chapter 2.First,we survey the monetary policies of representative central banks and point out that the unprecedented expansionary monetary policy is the direct cause of low interest rates.Central banks inject a large amount of liquidity into the economy,which directly lead to lower interbank interest rates and public debt interest rates.Second,we survey the long-term trends of real interest rates of world and representative countries,from which we find the law of continuous decline in real interest rates.We point out that the downward trend of real interest rates reflects the continuous decline of natural interest rates,that is,lower natural interest rate is the underlying cause of low interest rates.In the context of declining natural interest rates,monetary policy rates need to respond to natural interest rates,leading to a more expansionary monetary policy.Finally,we further find that factors such as slower technological innovations,declining population growth,deteriorating population structure,and greater income inequality have significant explanatory power for the decline in natural interest rates,which provides useful implications for policy makers.We study the macroeconomic impact of low interest rates in Chapter 3.We discover the inverted U-shaped relationship between steady-state interest rate and steady-state output and answer the question why interest rates are not the lower the better.First,we point out through theoretical analysis that,due to the ignorance of risk factors,existing theoretical research is difficult to explain the phenomenon that the output remains low under low interest rate conditions.This is because the real marginal output of capital(MPK)based on Cobb-Douglas production function is always positive.When the real interest rate is negative,it is always profitable for entrepreneurs to increase investment.Second,we introduce risk factors into the production function and find an inverted Ushaped relationship between steady-state output and steady-state interest rate by constructing a partial equilibrium model.We assume that high-quality investment projects are limited,so entrepreneurs will first implement low-risk projects and then implement high-risk projects when investing.Therefore,when the steady-state interest rate is low,high-quality investment projects are scarce.As investment costs improve with the decline in interest rates,entrepreneurs will become capable and willing to implement riskier marginal investment projects.It means that low interest rate promotes output by increasing the total amount of investment,while it also restrains output by increasing investment risk.The two channels function together and lead to the inverted U-shaped relationship between steady-state output and steady-state interest rate.Third,we find an inverted U-shaped relationship between economic development and real interest rates based on the research samples of 122 countries(regions)from 1970 to2018.It provides empirical evidence for the conclusions of theoretical research.Finally,we discuss the trade-off between economic growth and development quality under low interest rate conditions.We suggest that low interest rates encourage enterprises to take excessive risks,which leads to an economic condition with lower development quality.We study the microeconomic impact of low interest rates in Chapter 4,which provide further evidence for Chapter 3.First,We find an inverted U-shaped relationship between corporate operating performance and real interest rates based on the 2007-2019 research samples of Chinese listed corporations.It means that even in the micro level,interest rate is not the lower the better.Second,we find the decline in real interest rates significantly increases corporate operational risk through mechanism analysis.It proves the existence of risk channels,that is,the decline in real interest rates reduces the quality of economic development under low interest rate conditions.We study the policy response to low interest rates in Chapter 5.We mainly discuss the optimal monetary policy under low interest rate conditions.Based on the inverted U-shaped relationship between steady-state output and steady-state interest rate,we define the low interest rate condition as the condition where steady-state interest rate is lower than the optimal interest rate.First,we survey the negative interest rate policy practices of representative central banks and indicate that the development of digital currencies provides new possibilities for large-scale negative interest rate policies.Second,we find the constraints of natural interest rates on monetary policy,based on which we suggest that even discretionary monetary policy is actually responding to natural interest rates.Third,we introduce risk factors into the production function.We then divide economic conditions into normal interest rate conditions and low interest rate conditions in a dynamic stochastic general equilibrium model by controlling the household's utility of financial assets.Through impulse respond analysis,we find that the response of output and inflation to expansionary monetary policy diverge in low interest rate conditions,which means that the expansionary monetary policy suppresses output while stimulating inflation.This is because enterprises have already taken excessive risks in low interest rate conditions.On this basis,we suggest that the natural interest rate rule encourages excessive risk-taking in low interest rate conditions,which is detrimental to economic quality and is no longer the optimal policy rule.Finally,we point out that monetary policy has a limited role in solving the low interest rates problem.Government should focus on the structural issues that lead to the decline of natural interest rates and implement precise measures to solve the problem.We conclude and provide policy implications in Chapter 6.First,government should view the functions and limitations of monetary policy rationally.Expansionary monetary policies cannot solve all problems.Further large-scale expansionary policies in low interest rate conditions can only be "drinking poison to quench thirst." Second,the core of the low interest rate problem is the excessively low natural interest rate.Government should focus on the structural issues such as slower technological innovations,slowing population growth,deteriorating population structure,and greater income inequality.This study has following marginal contributions.First,we focus on the rules in low interest rate conditions.The research issues are important and the research perspective is novel.We divide economic conditions into normal interest rate conditions and low interest rate conditions.We then indicate that due to the excessive investment risks,response of output and inflation to expansionary monetary policy diverge under low interest rate conditions.It explains the phenomenon that unprecedented expansionary monetary policies are still unable to stimulate economic recovery.Second,we introduce risk factors into the production function,based on which we suggest that the decline in interest rate will not only promote total output through increasing total investment,but also restrain total output through increasing investment risk.The two channels jointly determine the inverted U-shaped relationship between total output and interest rates.Third,we find the important trade-off between economic growth and quality,based on which we suggest the natural interest rate rule is detrimental to economic quality in order to achieve price stability,so that it is no longer the optimal policy rule under low interest rate conditions.It explains the cost of expansionary monetary policies and provides new perspectives for monetary policy.Fourth,we discover the rule of longterm decline in real interest rates and find that factors such as slower technological innovations,declining population growth,deteriorating population structure,and greater income inequality have significant explanatory power for the decline in natural interest rates,which provides useful implications for policy makers.