Based on the latest economic data and expert analysis, several factors will determine interest rates in the long term. These include:
1. High government borrowing due to investment needs, such as climate spending or military expenses, leading to rising interest costs. This could cause higher deficits, resulting in a premium demanded by bondholders and higher rates. However, slower productivity gains and subdued potential growth could mitigate the impact on rates.
2. Demographic changes, particularly the aging population in advanced economies, which could lead to higher rates due to increased dependence ratios and potentially higher spending needs. However, the exact impact is uncertain and debated by economists.
3. The economic consequences of climate change, which could require significant investment and potentially cause higher inflation and price volatility. While some experts believe this could raise rates, others argue that the damage caused by climate change could actually lower R-star due to reduced productivity.
4. Technological advancements, such as artificial intelligence (AI), which could either significantly boost productivity and raise rates or have little impact. The extent of the productivity boost is still being debated by economists.
5. Supply-shock risks, such as pandemics, wars, and trade tensions, which could require central banks to act and potentially raise rates. Additionally, “friendshoring” initiatives aimed at trading more with allies instead of China could result in higher inflation due to decreased reliance on cheaper production locations.
Overall, the outlook for interest rates remains uncertain, with differing opinions among economists regarding the impact of various factors. Some experts predict higher rates, while others suggest rates may actually decrease due to lower R-star levels. Market indicators also currently suggest high rates, with bond traders betting on Federal Reserve cuts potentially not occurring until late 2024. Further economic data, particularly inflation and consumer spending updates, will provide greater insight into the direction of interest rates in the coming months.
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