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The Puzzle of Low Interest Rates

  • December 04, 2020

That means that institutions like universities that use the return on their endowments to fund their activities will need to tighten their belts. It also means that individuals will need to rethink retirement saving. According to my calculations, to support any given level of spending for a 20-year retirement, a person’s nest egg entering retirement needs to be 19 percent larger. For much the same reason, public and private pension plans are probably more underfunded than current estimates suggest.

There are, however, also upsides to the decline in interest rates. Young families looking to buy homes, for example, benefit from the lower cost of mortgage financing.

Some economists have suggested that with interest rates so low, the government need not worry much about increases in government debt. That is probably right, to a degree. Although government debt is near its highest point as a percentage of gross domestic product, servicing it hasn’t been a problem.

But interest rates could always return to more normal levels. If so, servicing the debt would become more costly.

Moreover, some of the causes of low interest rates might give reason for concern. For example, if they reflect low growth expectations, then counting on strong growth to reduce the debt-to-G.D.P. ratio, as the United States did after World War II, might not be an option.

In the end, low interest rates are a double-edged sword. We don’t yet know which edge will be sharper.

N. Gregory Mankiw is the Robert M. Beren professor of economics at Harvard.

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