Causes and implications of the low level of the risk-free interest rate

In most advanced economies, risk-free interest rates – i.e. the rates applicable to assets with minimal credit risk – have fallen to historically low levels over the recent period, in both nominal and real terms. These interest rates are particularly important because they serve as the basis for pricing other interest rates in the economy. The article looks at the current level of nominal and real risk-free interest rates in a historical perspective. Next, on the basis of an analytical framework of interest rate determinants, it describes the main factors behind the developments in risk-free interest rates in the United States and in the euro area since 1990. It then discusses how a low interest rate environment helps to safeguard macroeconomic stability – and hence price stability – but also deals with the potential risks for financial stability that such an environment may imply. Finally, it considers two specific interest rate risks in more detail. In particular, it illustrates the challenges which persistently low interest rates present for the insurance sector and for pension funds, as well as the risks stemming from a sudden rise in interest rates.