Fed Economist Sees Long-Term Rates Near Zero in Mild Downturn

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One of the Federal Reserve Board’s top economists said a U.S. recession could drive both short- and longer-term Treasury yields close to zero, limiting the tools the central bank has to aid the economy.

Michael Kiley, a deputy director in the Fed Board’s financial stability unit, said even a moderate recession in the U.S. “may result in near-zero interest rates at long maturities, bringing U.S. experience closer to that seen in Europe and Japan.” The research was published on the Fed Board’s website on Wednesday.

The Fed’s overnight policy rate was cut to almost zero in 2008 and held there until 2015, but longer-term rates remained well above that level.

The conclusion from the research raises questions about the potential effectiveness in the next downturn of redeploying crisis-era quantitative easing, where the Fed buys longer-term Treasury debt to push down yields and lower borrowing costs across the spectrum. That’s because longer-term yields may already be low or heading lower, so there might not be much more economic benefit to get from undertaking asset purchases to achieve that goal.

Former Chairman Ben Bernanke raised a similar caution in a Jan. 4 blog post.

Read more: Bernanke Says Fed Has the Tools It Needs to Fight Next Recession

Kiley pointed out that U.S. rates are already low and “decline notably” for several years after a recession. He pointed out that the average decline in the U.S. 10-year Treasury yields during the 1990 and 2001 recessions, which were both relatively moderate, was 1.7 percentage points, based on the move six months before the recession began and two years afterwards. Ten-year yields were 1.87% in afternoon New York trading on Wednesday.

He said the research suggests that zero rates would be hit for “maturities from one-day to seven or ten years.”

“These scenarios highlight the possibility that a recession in the United States would bring nominal interest rates to unprecedented levels, potentially implying limits on the ability of monetary policy to support a recovery,” he said.

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