If short term interest rates drop from .1% to .02% does it generate more economic activity? If long term rates drop from 3% to 2% (or even 1.7% as with 10 year US Treasury Notes), will people want to borrow more given the current economic environment? Most readers know my pessimism regarding answers to these questions. The IMF, in its latest global financial stability report, makes the case quite strongly. Furthermore, as argued previously and by most “Austrians” since Mises and Hayek, overly cheap capital causes a great deal of mis-allocation of capital. The Financial Times editorial today summarizes the IMF report.
The IMF’s latest global financial stability report says rightly enough that the eurozone crisis, and the row over the US debt ceiling, sparked an increase in risk aversion. But the IMF worries that exceptionally low interest rates are building a fresh credit problem. They have spurred a hunt for yield which, as widely broadcast, has sent too much capital to emerging markets. When capital is too cheap, it is mis-allocated.
The FT editorial concludes:
Either credit markets see reasons for economic cheer that have eluded everyone else, or low interest rates have sparked another round of irresponsible lending.