The U.S. Federal Reserve (Fed) has diagnosed that there is still a possibility of lowering the benchmark interest rate back to 'zero (0%) level' in the medium to long term. This is the first time the Fed has formalized a scenario for returning to near-zero interest rates after a period of aggressive rate hikes following the COVID-19 pandemic.
According to a joint report released on the 8th by researchers from the Federal Reserve Banks of New York and San Francisco, there is still a significant probability that the benchmark interest rate may need to be lowered to around 0% in the medium to long term. John Williams, president of the New York Fed and co-author of the paper, noted, 'The risk of re-entering zero interest rates has decreased compared to the past, but considering the recent high level of uncertainty, it cannot be completely ruled out.'
The Fed lowered the policy interest rate to nearly 0% during the global financial crisis in 2008 and the COVID-19 crisis in 2020. Subsequently, in response to inflation, it began aggressive rate hikes starting in 2022. The current federal funds rate remains at 4.25% to 4.5%.
The report pointed out that if a return to ultra-low interest rates becomes a reality, the Fed would find it difficult to stimulate the economy through traditional interest rate adjustments alone. In fact, since the pandemic, the Fed has been employing unconventional measures such as large-scale bond purchases, expanding asset holdings, and clear communication about future policy directions. These actions have resulted in a rapid expansion of the Fed's balance sheet.
The market expects the Fed to lower the benchmark interest rate to around 3.4% by 2027, and there are discussions about the possibility of starting cuts within this year. However, political variables such as the re-election of President Donald Trump and the resulting pressure for easing policies could serve as constraints on the Fed's policy operations.
The report also analyzed, 'The higher the expected interest rate, the lower the risk of re-entering zero interest rates; however, the greater the uncertainty about interest rates, the higher that risk becomes.' This aligns with the change in the Fed's perception regarding the 'neutral interest rate,' which neither overheats nor contracts the economy. Currently, the Fed has adjusted its neutral interest rate upward to around 3%, suggesting that there is less room for rates to drop to ultra-low levels even if they are cut in the future.
Experts believe that 'if concerns about long-term low growth and deflation resurface, the Fed could reintroduce interest rates close to zero,' and described it as 'a preemptive guard to maintain policy flexibility.'