Reassessing Zero Lower Bound Risk: Safe Assets and Interest Rates Post Pandemic

The zero lower bound—a natural limit on the extent to which interest rates can be reduced—has been instrumental in shaping U.S. monetary policy in recent decades. However, since the pandemic recovery, the interest rate landscape has begun to change. Estimates of where the federal funds rate will settle over the longer run have moved higher, and financial markets are pricing lower odds of future encounters with the zero lower bound. Understanding the forces behind these changes is important for judging whether they signal a fleeting or lasting change to the interest rate environment. In this article, Brent Bundick and A. Lee Smith review how factors that determine the longer-run normal level of interest rates have evolved since the pandemic. They find that a large increase in the stock of U.S. government debt, viewed as a safe asset across the world, has likely contributed to the apparent increase in the normal level of interest rates since 2020. Their results suggest that if the supply of government debt remains elevated relative to demand, the risk of encounters with the zero lower bound could remain lower than in recent decades.