IT is curious to reflect that when US and UK policy interest rates were cut to their lowest ever levels in March 2009, markets expected them to rise within the year. More than six years later the rates remain the same and markets are still obsessed with the timing of a rise. When that will happen is as clear as mud after the Federal Open Market Committee’s statement last week.

It is beyond doubt that ‘normalisation’ of monetary policy is a long way off. Janet Yellen, chairwoman of the Federal Reserve, has indicated that when the rises come they will be small, incremental and predictable. For some years we will be in a subnormal interest rate world.

It will also be a low growth world - witness the downward revisions to growth projections of the Federal Reserve and Bank of England this month. The eurozone and Japan, despite enjoying the benefits of big competitive devaluations, are struggling to deliver decent growth rates.

And competitive devaluation is anyway a zero sum game that does nothing to boost the global economy. China is slowing palpably even if the official figures are disguising the underlying reality. The post-crisis assumption that emerging market economies would show the developed world a clean pair of heels now no longer holds.

It is beyond doubt that ‘normalisation’ of monetary policy is a long way off. Janet Yellen, chairwoman of the Federal Reserve, has indicated that when the rises come they will be small, incremental and predictable. For some years we will be in a subnormal interest rate world

Against a background of inadequate global demand the collapse in energy and commodity prices has added powerful disinflationary impetus. Wage increases in the developed world, with the notable exception of the UK just recently, have been subdued.

Forward markets are telling us that interest rates are going to be far lower than pre-crisis average policy rates since 1945 for the US, UK, the eurozone and Japan, which were respectively 3pc, 7pc, 3pc and 4pc.

In other words, the markets are saying that this time is different, a formulation that is reliably dangerous when it comes to predicting the future. Of course, some things really are different. For much of the post-war period most central banks were not independent, though whether independence has been the driving force behind prolonged disinflation is another matter, as is the question of whether central banks will remain independent in future.

Given the quasi-fiscal nature of their activities since the crisis and the risk that unconventional measures pose to their balance sheets, the possibility of a political land-grab in monetary policy is not negligible.

On the other hand, liberalisation of labour markets and the decline of union power seems unlikely to be reversed in short and medium term. Note that with ageing populations, a shrinking workforce may exercise market power to grab higher wages against a retired population that tries to use voting power to secure stable retirement incomes.

The dangers inherent in a subnormal interest rate world relate, first, to the accumulation of debt. Debt of almost any size in relation to gross domestic product becomes manageable at today’s negligible interest rates. Whether it stays manageable depends on whether politicians seize the opportunity to deliver structural reforms and infrastructure investment to enhance growth, without which debts cannot ultimately be serviced.

The snag is that low growth makes it hard to summon up the political will for reform, which tends to impede growth in the short run before producing a longer-term pay-off.

Then there is dismal investment returns and the impact of low discount rates on pension fund liabilities. It is impossible to know how far pension fund deficits dampen animal spirits in the boardroom, but where pension funds are big in relation to the company, deficits cannot help.

They may well have been a factor, albeit a minor one, in the weakness of investment since 2008. Equally important, a subnormal interest rate environment reduces the scale of creative destruction and confers advantage on big companies at the expense of more productive smaller companies that lack good access to credit markets.

In such a world any reversion to the historic interest rate mean is distant. There is no generalised sword of Damocles hanging over the heavily indebted developed world for now. Yet for individual countries an early reversion may be the reward for bad policy. Japan and southern Europe are the laboratories in which this hypothesis will be tested.

The writer is an FT columnist

Published in Dawn, Economic & Business, June 29th, 2015

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