Higher interest rates are here to stay, so we need a rethink
Even with the recent part retreat in long-term real and nominal interest rates, they remain well above the ultralow levels to which policymakers had grown accustomed, and they are likely to stay at such levels even as inflation retreats. It is now past time to revisit the widely prevailing “free lunch” view of government debt.
The idea that interest rates would be low for ever seemed to support the view that any concern about debt was an endorsement of “austerity”. Many came to believe that governments should run large deficits during recessions and only slightly smaller deficits in normal times. No one seemed concerned with the possible risks, in particular to inflation and interest rates. The left championed the notion that government debt could be used to expand social programmes, going beyond what could be generated by reducing military spending, while those on the right seemed to believe that taxes exist only to be cut.
The most misguided approach involved using central banks to purchase government debt, which appeared costless when short-term interest rates were zero. This idea is at the core of modern monetary theory and “helicopter money”. In recent years, even prominent macroeconomists have floated the idea of having the US Federal Reserve write off government debt after soaking it up through quantitative easing, a seemingly simple solution to any potential sovereign debt problem.
But this approach assumed that even if global real interest rates rose, any increase would be gradual and temporary. The possibility that a sharp rise in interest rates would dramatically increase interest payments on existing debt, including debt held by central banks as bank reserves, was simply dismissed. But here we are: the Fed, which previously paid zero interest on these reserves, is now paying more than 5%.
Aside from a few notable exceptions, those who championed the notion that debt is a free lunch have not acknowledged the likelihood of a new reality. At a recent conference, I listened to a well-known financial commentator who had been a staunch advocate of the “lower for ever” narrative and seemed unaware that it had been thoroughly debunked. When pressed, they conceded that if interest rates do not quickly revert to the ultra-low levels of the 2010s, budget deficits might matter after all. But they were reluctant to admit that the existing debt overhang could pose a problem, as this would impugn their previous endorsements of spendthrift fiscal policies.
Similarly, in a recent paper about the record levels of global debt, presented to the world’s leading central bankers at this year’s Jackson Hole conference, Serkan Arslanalp and Barry Eichengreen appeared reticent to discuss the implications of the current debt overhang or the connection between high government debt and sluggish growth in countries such as Japan and Italy.
To be sure, the next recession, whenever it occurs, will probably lead to a significant decrease in interest rates, potentially offering a temporary respite to the wildly overleveraged US commercial real-estate market, where the mantra today is “stay alive until ’25”. If property owners can endure another year of falling rents and soaring financing costs, the thinking goes, a sharp drop in interest rates in 2025 could stem the tide of red ink threatening to drown their businesses.
But even if inflation declines, interest rates will probably remain higher for the next decade than they were in the decade after the 2008 financial crisis. This reflects a variety of factors, including soaring debt levels, deglobalisation, increased defence spending, the green transition, populist demands for income redistribution, and persistent inflation. Even demographic shifts, often cited as a rationale for perpetually low interest rates, may affect developed countries differently as they increase spending to support rapidly ageing populations.
While the world can certainly adapt to higher interest rates, the transition is still ongoing. The shift could be particularly challenging for European economies, given that ultra-low interest rates have been the glue holding the eurozone together. The European Central Bank’s “whatever it takes” bailout policies appeared costless when interest rates were near zero but it is unclear whether the bloc can survive future crises if real interest rates remain high.
As I have previously argued, Japan will struggle to move from its “zero for ever” interest rate policies, as its government and financial system have grown accustomed to treating debt as cost-free. In the US, the commercial real estate sector’s vulnerabilities, together with increased borrowing, could trigger another wave of inflation. Moreover, while major emerging economies have managed to cope with high interest rates so far, they face enormous fiscal pressures.
In this new global environment, policymakers and economists, even those who previously belonged to the “lower for ever” camp, may need to reassess their beliefs in light of current market realities. While it is feasible to expand social programmes or boost military capabilities without running large deficits, doing so without raising taxes is not costless. We are likely to find out the hard way that it never was.
• Kenneth Rogoff is professor of economics and public policy at Harvard University. He was the IMF’s chief economist from 2001-03.
© Project Syndicate
vron’s Gorgon gas facility in Western Australia is the site of the world’s largest industrial CCUS project, which, during its first five years, missed its carbon capture targets by about 50%. Earlier this year the Guardian reported that emissions at the gas facility have risen by 50%.
Critics say CCUS and other abatement technologies would fail to tackle the 5 million annual deaths linked to air pollution caused by extracting and burning fossil fuels.
Internal industry documents released by the US House oversight committee’s investigation into climate disinformation in 2021 suggest that oil executives are aware of CCUS’s limitations – and its potential as a lifeline for fossil fuels.
Earlier this year, the chief executive of the US oil company Occidental, Vicki Hollub, who is registered as a Cop28 delegate,told an industry conference that direct air capture “gives our industry a licence to continue to operate for the 60, 70, 80 years that I think it’s going to be very much needed”. Occidental said the CO2 captured in Texas would be stored underground and used as a sort of carbon credit system for other companies to buy. It touts itself as an example of “net zero oil”, whereby removed CO2 is injected into rock formations to dislodge gas and oil for further extraction.
Rachel Cleetus, the climate and energy policy director at the Union of Concerned Scientists, said: “Fossil fuel and narrow political interests are choosing to obfuscate and water down the text being negotiated for the final Cop28 agreement, despite the clarity science brings to the necessity of a phase-out.
“The reality is that CCS/CCUS cannot contribute meaningfully to emission reductions in this critical decade … The core, unavoidable task remains making deep, direct cuts in fossil fuel use. There are no escape hatches.”
The 475 CCS lobbyists were identified from the UN’s provisional list of about 84,000 participants at Cop28, and include representatives of companies that have partnered in carbon capture and utilisation or storage projects, according to an International Energy Agency database, as well as other companies and organisations that have a public record of advocating for these technologies.
Blessed Chidhoni, from the Global Campaign to Demand Climate Justice, and who lost family members during floods in Zimbabwe, said: “Thousands of fossil fuel lobbyists are roaming these halls alongside their peers, advancing dangerous distractions like carbon capture and storage, trying to block a fast, fair, forever fossil fuel phase-out – while communities enduring the greatest impacts from the climate crisis are having our voices silenced and our lives treated as a worthy sacrifice for profit.”
A spokesperson for the Carbon Capture and Storage Association said: “Carbon capture technology will be a significant part of the mix alongside reducing energy use and the rolling out of renewable electricity as we all work together to reach net zero.”