American horror story: The US could turn into a zombie economy if it’s not careful

This strategy, also known as ‘yield-curve control,’ is tempting and it may even provide an immediate boost to the economy. But messing with rates would be a mistake. Japan’s experience shows that the long-term costs of keeping rates artificially low far outweigh the short-term benefits.

It’s easy to see the hardship caused by higher interest rates. In the US, rates on long-term bonds (ones that mature in 10 years or more) have trended up since the covid pandemic.

This means consumers pay more for their debt and mortgages. Businesses pay more for loans. The government pays more to service its debt. A lot of the US economy is built around the historically low rates of the last several decades, so the longer interest rates stay high, the more disruption it will cause.

AI poses another challenge. Even the best-case scenario—artificial intelligence (AI) transforms the economy, making Americans richer and more productive—will involve lots of disruption. Some people will lose their jobs and some jobs will never get created in the first place. Some businesses will fail or never get started. Higher interest rates will mean that firms that are barely hanging on will face a higher cost of capital to keep their businesses viable and their people employed.

So the government will want to do what it can to lower long-term interest rates. Conventional monetary policy tends to influence short-term rates; markets set the longer-term rates. And many market forces point to higher rates for longer. The government can influence long-term rates through policies like quantitative easing (QE), where the central bank buys long-term bonds. The government can also lower rates by requiring pension funds or banks to buy lots of bonds. But it is risky.

Japan offers a cautionary tale. It faced a slowing economy following the boom years of the 1980s. To keep its economy afloat, it kept long-term interest rates low with a mix of financial repression and QE. To some extent, it worked. Japan muddled through decades of low growth and high debt with a good standard of living, relative stability and not much job loss. It became the poster child for why nations can run up as much debt as they’d like.

But there is a cost to keeping rates artificially low for too long. Japan is full of what’s known as ‘zombie companies’: firms that aren’t profitable and don’t have a viable business model, but can stay afloat with cheap debt. Eventually, however, when inflation returned and interest rates around the world increased, Japan had to let its rates rise too.

Those zombie companies are now going out of business as many family-run firms declare bankruptcy. It is a sad and painful process on a human level and it hurts the broader economy as well. These zombie companies made Japan’s economy less efficient and slower-growing, and also left generations of Japanese people working at unprofitable businesses.

It will be tempting for the US and Europe to engage in some financial repression in the coming years to force interest rates lower. Not only will it make America’s addiction to debt seem manageable, it will help ease the transition to an AI economy. But cheap debt will also let more zombie companies survive that would otherwise be displaced by technological change.

US President Donald Trump’s administration is already hinting at the possibility. Trump certainly wants lower short-term rates and his treasury secretary Scott Bessent has been vocal about his desire to lower long-term rates too. How America might do so, however, remains unclear; Bessent has also said that he is sceptical of further quantitative easing.

He is right to be. If the Japanese experience isn’t an adequate warning, he can look closer home. Some of America’s current economic problems are the result of past forays into yield-curve control. The US Federal Reserve’s QE during the pandemic is still causing problems in the housing market—it artificially lowered mortgage rates, which then went up when inflation returned.

Meanwhile, the US Treasury is losing money on its bond portfolio and the bond market is experiencing dislocations as the Fed reduces its large post-pandemic balance sheet.

All this is the result of only a few years of trying to control the yield curve. If it becomes normal policy, expect worse distortions and more threats to Fed independence. Japan’s policies, followed for decades, created thousands of zombie firms. The danger for the US is that financial repression, pursued on a large scale, would create a zombie economy. ©Bloomberg

The author is a Bloomberg Opinion columnist covering economics.