Inflation Eats Interest in Advanced Economies

Central bank interest rates in advanced economies have started to rise again from zero-percent territory in 2022, but because of rampant inflation, any potential returns were completely diminished that year, creating savings that were effectively shrinking.

In 2022, real interest in 34 advanced economies analyzed by the IMF stood at -5 percent. In emerging and developing economies, real interest remained positive, but also fell to just 1.2 percent. The data, part of the IMF’s April economic report, shows that both types of economies used to experience similar changes, for example during the Great Recession of 2008/09 and its recovery, but decoupled after 2011 – with real interest rates in advanced economies becoming increasingly lower.

In its report, the IMF says it expects the real interest rates in advanced economies to return to their pre-pandemic levels. However, this might also be unsatisfactory for savers as those rates hovered around 0 percent. The bigger problem here is that real interest rates have been in a shrinking in general in these countries, which is thought to happen due to aging populations and decreasing productivity. With economies lagging in this way, central banks are forced to keep interest rates low to maintain their previous levels of output – with the result that inflation is quickly eating up the meager returns that are provided. Due to this conundrum, the real interest rate is also referred to as the natural interest rate – the rate that neither grows nor diminishes the economy – due to it being governed by market forces.

Critics of this theory think that the natural interest rate in advanced economies will once again rise since productivity could be heightened by technological advances. Additionally, the burdens of aging populations, while anticipated, are not generally acted upon by governments, meaning that they don’t actually take enough money out of the market to save for an upcoming population crisis.