So what will happen when central banks start raising interest rates? In 1994, rising short term rates caused increases in long term rates and declines in long term bond prices that were at least double what standard models at the time were predicting.

An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

In this case, the price of loanable funds is the real interest rate. An expectation that interest rates will be high sometime in the next decade should mean high interest rates on long term bonds today.

Either way, a rise in long term interest rates is liable to choke off the recovery.

It may have had something to do with the near total lack of response of long term interest rates to monetary tightening.

First, while the US Federal Reserve continued hiking short term interest rates, long terms rates did not increase in tandem, which allowed housing prices to continue rising.

One oft heard justification for high asset prices is that real (inflation adjusted) long term interest rates are very low.

Hence, real long term rates remained quite high in the mid 1980 s.

It also lowered long term interest rates in the US and made monetary conditions there more expansionary.

Remarkably, as short term interest rates rose, medium and long term interest rates did not, something that was referred to as a conundrum.

QE2, in which the Fed bought long term government bonds, did not have a discernible effect on long term government interest rates.

Within a couple years, interest rates on long term US Treasury notes could easily rise 3 4 , with interest rates on other governments paper rising as much, or more.

Yet financial markets are not pricing dollar depreciation and a rise in long term US interest rates accordingly.

In short, we simply shouldn t read too much into the decline in real long term interest rates over the last 20 years.

If interest rates were lowered beyond a certain point, the dollar would come under renewed pressure and long term bonds would actually go up in yield.

Here, monetary authorities must be vigilant, and continue their non standard interventions managing both short term and long term interest rates.

If central banks are tightening and long term rates aren t rising, one needs some explanation.

The low interest rate on long term Treasury bonds has also boosted demand for other long term assets that promise higher yields, including equities, farm land, high yield corporate bonds, gold, and real estate. When interest rates rise, the prices of those assets will fall as well.

A great puzzle in today s world economy is the continued low level of long term real interest rates in the United States.

Alternatively, low interest rates could push her (or her pension fund) to buy risky long maturity bonds.

A disorderly rush to the exit could lead to a dollar collapse, a spike in long term interest rates, and a severe double dip recession.

Moreover, there may be a financial panic large financial institutions with short term liabilities and long term assets will have a difficult time weathering a large rise in long term dollar denominated interest rates. This mismatch can cause financial stress and bankruptcy just as easily as banks local currency assets and dollar liabilities caused stress and bankruptcy in the Mexican and East Asian crises of the 1990 s and in the Argentinean crisis of this decade.

The Fed is engaged in the difficult task of trying to set not just the short term interest rate, but longer term rates as well.

These policies did succeed in lowering long term interest rates.

The resulting increase in real long term interest rates will reduce all forms of interest sensitive spending, adding further to the economy s weakness.

Nevertheless, there is some concern that growing inflationary expectations might result in rising long term interest rates, offsetting the benefits of the stimulus.

Ordinarily, rapid global growth translates into high long term interest rates that is, unless, deep down, people have become nervous.

Investors are buying long term bonds at the current low interest rates because the interest rate on short term investments is now close to zero. In other words, buyers are getting an additional 2 current yield in exchange for assuming the risk of holding long term bonds.

Investors are buying long term bonds at the current low interest rates because the interest rate on short term investments is now close to zero.

And the prospect of rising short term rates means that investors no longer need to hold long term bonds to achieve a higher return over the next several years.

Although long term government interest rates are now very low, they are beginning to rise in response to the outlook for a sharply rising national debt.

But lower short term interest rates have led to higher medium term interest rates, which are more relevant for the mortgage market, perhaps because of increasing worries about inflationary pressures.

Low long term interest rates have kept the region s debts manageable, while high consumer demand has helped bid up prices for the region s commodity exports.

Indeed, America has been the single biggest beneficiary of this freakish low interest rate environment, with everyone seeming to borrow money like it is going out of style.

He has cut short term interest rates to the bone.

Moreover, low long term interest rates are a thing of the past.

The dollar will fall and US long term interest rates will rise, but only when traders on Wall Street and elsewhere decide that holding dollars and long term US bonds is more risky in the short run.

Indeed, elevating long term asset prices was precisely the point of lowering interest rates making bondholders and especially real estate owners richer, after all, provides a fillip to spending.

This led to a plan to keep short term interest rates near zero until late 2014, as well as to massive quantitative easing, followed by Operation Twist, in which the Fed substitutes short term Treasuries for long term bonds.

The Federal Reserve s policy of long term asset purchases, also known as quantitative easing, has intentionally kept long term rates low.

Moreover, ECB chief economist Otmar Issing predicts long term interest rates would go up not down as inflationary expectations increased. So cutting interest rates would not only be stupid it would be crazy.

But if low long term interest rates are helping so many economies walk on water, why are rates so low, and will they stay that way? Perhaps the situation is far more fragile than many policymakers would have us believe.

Similarly, any financial institution that bets on a sharp rise in long term interest rates over the next five years in a serious, leveraged way also puts its survival at risk.

Moreover, ECB chief economist Otmar Issing predicts long term interest rates would go up not down as inflationary expectations increased.

Or, if these deficits are monetized, high inflation may force up long term interest rates and again choke off economic recovery.