Why Have Interest Rates Been Low?

This paper uses an estimated interest rate rule of the Fed to argue that the low recent interest rates may be due to a change in Fed behavior. Prior to the Great Recession the Fed’s behavior is consistent with the rule. During the recession the zero lower bound was hit in 2008.4. The rule unconstrained called for negative nominal interest rates during this period, and so it became inoperative. The Fed kept the interest rate at roughly zero through 2015. This was a period of low inflation and still fairly high unemployment rates, and the rule called for essentially zero interest rates through about 2010. Beginning in 2011, however, the rule called for rising interest rates, and between 2011 and 2019 the predicted interest rates from the rule are always higher than the actual rates. Between 2011 and 2019 the Fed was more expansive than its historical behavior as estimated by the rule. The COVID experience through 2022.1 also shows the Fed setting historically low interest rates beginning in 2021 in the face of rising inflation and falling unemployment. In short, the low recent interest rates may be because of a change in Fed behavior.