In addition, low interest rates minimize the cost to the United States of our substantial negative net debt position. In addition, the fact that our foreign indebtedness is for the most part denominated in our own currency is a huge advantage in the event the dollar were to come under significant downward pressure. That is because a decline in the dollar would raise the value of the income earned on our foreign direct investment and foreign-currency denominated assets, relative to the income that foreigners earned on their dollar-denominated investments in the United States. All else being equal, this would boost our net investment income balance. Note that borrowing per se is not necessarily a bad thing. The key is what the borrowing is used for – to finance consumption or investment. And, if it is used to fund investment, it is also important how productive that investment turns out to be over time. So what did we do with this inflow of foreign saving? We invested in a substantial volume of physical capital, particularly residential and nonresidential real estate (Chart 4). It seems clear that one important factor behind this investment was the decline in long-term interest rates. For example, from 2003 through 2005 mortgage rates declined to just under 6 percent on average, the lowest level since the first half of the 1960s. These lower mortgage interest rates were capitalized into asset prices. Rising prices for residential and nonresidential real  1  Brender, Anton and Florence Pisani. 2007.
Work done by my Federal Reserve colleagues, Thomas Laubach and John Williams, suggests that the so-called neutral real  BIS central bankers’ speeches  5  federal funds rate today may be close to zero. 4 This presumably reflects still-persistent headwinds from the financial crisis, such as the constraints on mortgage credit availability to prospective borrowers with lower FICO scores. Second, one might expect that it will still take additional time for these headwinds to fully subside. This implies that the neutral short-term rate may be depressed for some time. Third, my assessment is that the long-run equilibrium real federal funds rate is lower now than in the past, reflecting the likelihood that potential real GDP growth is lower due to slower growth of the labor force and more moderate productivity growth performance. Another important factor that will affect the trajectory of short-term rates is how financial market conditions respond to a rise in short-term rates. Monetary policy works on the economy through how it affects financial market conditions. Economic conditions at any point in time warrant a particular set of financial market conditions so the FOMC can best achieve its objectives of maximum employment and price stability. The FOMC chooses a policy stance to help support financial market conditions that will lead to economic outcomes consistent with its objectives. An important aspect of current financial market conditions is the very low bond term premia around the globe.