Over the next decade, the US economy will face two big challenges: higher interest rates and AI-generated disruption. Each invites the same solution: policies to keep rates below their market level. The strategy, also known as yield-curve control, is tempting, and it may even provide an immediate boost to the economy. But messing with rates would be a mistake.
Japan’s experience shows that the long-term costs of keeping rates artificially low far outweigh the short-term benefits.
### The Impact of Higher Interest Rates
It’s easy to see the hardship caused by higher interest rates. In the US, rates on long-term bonds (those that mature in 10 years or more) have trended upwards since the pandemic. This means consumers pay more on their debt and mortgages. Businesses face higher loan costs. The government also pays more to service its debt.
Much of the US economy has been built around the historically low rates of the last several decades. So the longer rates stay high, the more disruption it will cause.
### The Challenge of AI
AI presents another challenge. Even in the best-case scenario — where artificial intelligence transforms the economy, making Americans richer and more productive — it will still involve significant disruption. Some people will lose their jobs, and some jobs will never get created in the first place. Some businesses will fail or never get started.
Higher interest rates mean that firms barely hanging on will face a higher cost of capital to keep their businesses viable and maintain employment. For this reason, the government will want to do whatever it can to bring down long-term interest rates.
### Influencing Long-Term Interest Rates
Conventional monetary policy tends to influence short-term rates; longer-term rates are set by the markets. Currently, many market forces point to higher rates for the foreseeable future.
The government can influence long-term rates through policies such as quantitative easing (QE), where the central bank buys long-term bonds. Another approach is requiring pension funds or banks to buy large amounts of bonds — effectively suppressing yields.
But this is a risky plan.
### Lessons from Japan
Japan offers a cautionary tale. Facing a slowing economy after its 1980s boom, Japan kept long-term interest rates low through a mix of financial repression and QE. To some extent, this approach worked. Japan muddled through decades of low growth and high debt while maintaining a good standard of living, relative stability, and limited job loss. It became a poster child for the notion that nations can carry vast amounts of debt indefinitely.
However, there is a cost to keeping rates artificially low for too long. Japan is full of so-called “zombie companies”: firms that aren’t profitable and don’t have viable business models but can stay afloat with cheap debt. Eventually, when inflation returned globally and interest rates rose, Japan had to allow its rates to increase as well.
Now, many of those zombie companies are going out of business, with several family-run firms declaring bankruptcy. This process is painful on a human level, and it also harms the broader economy. The zombie companies made Japan’s economy less efficient and slower growing, trapping generations of workers in unprofitable businesses.
### The Risk for the US and Europe
It will be tempting for the US and Europe to engage in financial repression in the coming years by various means designed to force interest rates lower. Not only would this make the US’s addiction to debt seem manageable, it would help ease the transition to an AI-driven economy.
However, cheap debt would also allow more zombie companies — which technological advances would normally displace — to survive longer than they should.
The Trump administration has already hinted at this possibility. President Donald Trump wanted lower short-term rates, and Treasury Secretary Scott Bessent has expressed his desire to lower long-term rates too. How they might achieve this, however, remains unclear. Bessent has also voiced skepticism about expanding QE, and rightly so.
### Domestic Warnings
If Japan’s experience isn’t a sufficient warning, the US has more recent examples closer to home.
The Federal Reserve’s QE during the pandemic still causes problems in the housing market — it artificially lowered mortgage rates, which subsequently rose sharply as inflation returned. Meanwhile, the Treasury is losing money on its bond portfolio, and the bond market faces dislocations as the Fed reduces its large post-pandemic balance sheet.
All this happened after only a few years of attempts to control the yield curve. If such policy becomes normalized, expect worse distortions and more threats to the Fed’s independence.
Japan’s decades-long policies created thousands of zombie companies. The danger for the US is that prolonged financial repression on a large scale could create a similarly unhealthy “zombie economy.”
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*This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board, Bloomberg LP, or its owners.*
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is the author of *An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk*.
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