Markets rise but economy may be “stuck” with low interest rates

Markets mostly rose on Wednesday.

The S&P 500 rose 0.3 percent, the STOXX Europe 600 rose 0.1 percent and the Nikkei 225 rose 0.3 percent.

“In an environment of job growth, ultra-low interest rates and central-bank stimulus, this is actually an okay environment and one in which you need to be putting money into stocks because they can continue to go higher,” said Kate Warne, principal investment strategist with Edward Jones.

Indeed, a recent research paper suggests that US interest rates should have been even lower.

San Francisco Fed economist Jens HE Christensen wrote that based on the market response for five central banks that have introduced negative rates, “mildly negative U.S. policy rates from 2009 to 2011 could have supported higher economic growth and eventually pushed up inflation closer to the Federal Reserve’s target”.

On the other hand, former Bank of Japan governor Masaaki Shirakawa wrote that the focus on avoiding deflation by persistent monetary easing is wrong.

He said that the effectiveness of monetary easing derives from bringing forward future demand to the present. “If the economy is faced with a temporary shortfall in demand, this policy works,” he wrote.

However, “if there are bigger structural issues suppressing it -- the very act of monetary easing will make the 'natural rate of interest' fall faster, and eventually it will get stuck,” he said.

Indeed, the US central bank now appears to be needing ever greater liquidity injections to ensure financial stability.

On Wednesday, the New York Fed announced it is increasing its temporary overnight repo operations to US$120 billion a day from the current US$75 billion in an effort to hold the overnight funds rate within its target range.