The End of Cheap Money: Markets Face a Permanent Shift in Interest Rates
The era of historically cheap money is coming to a definitive close, forcing a potentially permanent adjustment to higher equilibrium interest rates that will challenge financial markets and government finances built on outdated assumptions, according to Damian Pudner. For nearly a decade until the pandemic, financial markets priced money as if it would remain inexpensive indefinitely, with governments borrowing freely, financial assets soaring in value, and abundant credit becoming a structural feature of the global economic landscape.
A Fragile Assumption and Shifting Dynamics
That long-held assumption now appears increasingly fragile and unsustainable. The critical question confronting investors is no longer simply where interest rates will settle through the economic cycle. It is whether the underlying price of money has shifted onto a higher trajectory permanently. If this shift has occurred, the implications extend far beyond central banks into sovereign debt dynamics, financial stability, and the valuation frameworks that underpin financial markets worldwide.
Cheap money profoundly shaped behavior across the entire financial system, and its withdrawal will inevitably do the same. The prolonged period of exceptionally low borrowing costs that followed the Global Financial Crisis was historically unusual, as real interest rates have typically been positive, often significantly so. Decade-long periods of ultra-cheap capital are rare in economic history.
Structural Forces and Changing Balances
This environment was not engineered by central banks alone; it reflected deeper structural forces. Productivity growth slowed, reducing the expected return on investment, while ageing populations increased desired saving, and strong global demand for safe assets compressed yields. Essentially, the world was saving more than it was finding productive ways to invest.
That balance now appears to be shifting dramatically. Government borrowing is at record levels and is unlikely to fall soon, forcing heavy demands on global savings just as vast investment requirements—from energy infrastructure to defence capacity—intensify competition for capital. The assumptions that underpinned hyper-globalisation look less secure, and if so, the implications extend far beyond central banks.
Implications for Economy and Policy
A structurally higher neutral rate would influence mortgage costs, corporate investment, asset valuations, and the fiscal arithmetic facing governments. When the price of money changes, the structure of the economy tends to adjust with it. Markets adapt quickly, but financial structures do not. Balance sheets built during an era of cheap money embed assumptions about refinancing costs, discount rates, and liquidity that are inherently slow to change.
By the time regime shifts are widely recognised, repricing is usually already underway, increasing the risk of policy error. Those assumptions are now being tested rigorously. Recent remarks from Bank of England chief economist Huw Pill underscore the uncertainty confronting policymakers. His warning that cutting rates prematurely could prove a policy error points to a risk markets may be underestimating—that the neutral rate itself is higher than previously assumed.
Central Bank Constraints and Fiscal Implications
For central banks, this creates a difficult constraint. Policy must restrain inflation without tightening into a neutral rate that may itself be drifting upward, a far more complex exercise than conventional rate-cycle narratives imply. The fiscal implications alone deserve serious attention, as independent central banks operate within fiscal states, not outside them.
Higher debt levels mean interest-rate movements now carry significantly larger budgetary consequences and narrow the room for policy manoeuvre. No wonder talk of fiscal dominance, once largely academic, is quietly returning to mainstream policy discussion. This occurs when the central bank must take account of the government’s financing needs to such an extent that maintaining price stability becomes secondary to ensuring debt sustainability.
Lessons from History and Future Outlook
History is unequivocal: periods of stability encourage leverage, invite excessive risk-taking, and compress risk premia—often until markets forget why those premia existed at all. The real mistake is to assume that the monetary conditions of the past decade were permanent rather than an anomaly. None of this implies that rates will remain permanently elevated; cyclical downturns will still pull borrowing costs lower at times.
However, equilibrium rates may settle structurally higher than investors became accustomed to during the 2010s. A more fragmented geopolitical order may also introduce greater volatility around that path. Investors should think less in terms of point forecasts and more in terms of distributions. Beyond any single policy meeting, the cost of capital will eventually reflect inflation expectations, wage dynamics, productivity growth, and fiscal credibility.
High debt is manageable, but high debt in a world of structurally higher rates is not. Cheap money shaped a generation of financial behavior, and the global economy now appears to be entering a more expensive era of capital. Balance sheets built for the old world may not withstand the discipline of the new. Markets are patient, but they are rarely patient indefinitely.
Damian Pudner is director of the Institute of International Monetary Research.
