Moreover, even these estimates may overstate the future path of interest rates implied by financial markets. Market interest rates are probability-weighted averages of different possible interest rate paths – they are a mean. Model estimates of the modal – or most likely – path for interest rates are lower still (Chart 3). Estimates of the modal path of interest rates are drawn from estimated models, so are no more than illustrative. Nonetheless, the modal interest rate three years ahead in the US is  1  Expected lift-off here refers to a 25 basis point increase. 2  The path of forward interest rates will also be affected by term premia. See Shafik (2015). BIS central bankers’ speeches  1  only 1.1%. In the UK it is 0.8%, little changed from current levels. According to these estimates, the glue holding interest rates to the floor looks stronger still. There is an old English aphorism, due to Walter Bagehot in the 19th century: “John Bull can stand many things, but he cannot stand 2%”. Prior to 2009, the Bank of England had been careful to avoid the wrath of Mr Bull: Bank rate had never been below 2% in its then-315 year history. For the past six years the MPC has been testing the patience of Mr Bull, with the 2% threshold consistently breached. If financial markets are to be believed, Mr Bull, Mrs Bull, and their children are set to have their patience tested further: UK rates are not expected to reach 2% until 2019.
The world has in the past experienced lengthy periods of continuously positive annual growth: in the UK, for a remarkable 26 years after the Second World War and for 16 years during the Great Moderation starting in the late 1990s. As Chart 12 shows, however, these are extreme outliers in the distribution of expansions. The probability of an expansion lasting for longer than 10 years is, on past evidence, less than 10%. 5  Assuming these probabilities evolve according to a Bernoulli distribution – that is to say, the probability of a recession triggering shock occurring in one year is independent of the probability of a shock occurring in another year. This probability is calculated by looking at data on the frequency of negative annual growth rates. The cumulative probability is the probability that there will be at least one such shock over a given horizon. 6  Using conditional probabilities – for example, on starting in recession or expansion – does not dramatically alter these cumulative probabilities. BIS central bankers’ speeches  5  If a recession were to strike in the period ahead, a relevant question for monetary policy is how much room for manoeuvre might be necessary to cushion its effects. History can again offer some guide. Table 1 looks at loosening cycles in the UK, US, Germany and Japan in the period since 1970 and in the period since 1994. There has been considerable variation in the scale and duration of loosening cycles over time and across countries.