This construction with companies that have invested in assets that are difficult to value and have a long duration and which have financed themselves in the short-term money market with a guarantee from the banks is a powder keg – and a powder keg where the powder has been piled up more quickly and to a greater extent than both the market and the authorities have been aware. The igniting spark came from the US mortgage market, but it could have come from other areas. 2  BIS Review 136/2007  Bad credits in the US mortgage market is the igniting spark In the United States the financial innovations have gone hand in hand with a rapid increase in loan volumes. As is the case in most of the world, it is mainly households’ mortgages that have increased. What distinguishes the United States in this respect is that a not insignificant portion of the mortgages have been taken by households with poor credit ratings. 1 These loans are called subprime loans. Although the subprime loans constitute a minority of the total mortgages, there are nevertheless significant sums involved. 2 It is worth pointing out here that of course it is not always wrong to grant loans for housing merely because the lenders cannot manage the banks’ normal, fairly tough criteria. But it is always necessary to carry out a proper credit assessment. And the lender should be paid for the higher risk through a correspondingly higher interest rate. None of this happened in the United States.
As R* has fallen, monetary policy has moved with it. This is an important point. The low level of interest rates over the past few decades reflects deep underlying factors on the supply side of the economy. As these underlying factors – trends in technology and demographics – only move slowly, it is not unreasonable to expect that R* will remain low. This means that, even as we now respond to rising inflation by raising Bank Rate, interest rates will not necessarily have to return fully to, and remain around, the higher levels they once had. But let me add a caveat: “It’s important to note that forecasting the future path of R* is challenging and subject to a significant degree of uncertainty. Economic developments and policy decisions can have unpredictable and complex effects on the economy, and it is difficult to predict their outcomes with complete accuracy.” This was not said or written by an economist of the human sort. This is a caveat added by ChatGPT. The ‘artificial intelligence’ underlying it reminds us that technology sometimes progresses in leaps, which can lead to a sudden emergence of productive investment opportunities across the global economy. New rounds of technological revolution are amongst the factors that could shift up Global R*. Monetary policy would have to move with it. So even if monetary policy is neutral in the long run, long-run supply does affect monetary policy by anchoring the level for interest rates.