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Fed's Williams sees more financial stability risk with low rates

San Francisco Federal Reserve President John Williams speaks to Reuters in San Francisco, California, U.S. September 27, 2016. REUTERS/Stephen Lam

SAN FRANCISCO (Reuters) - San Francisco Federal Reserve Bank President John Williams warned Tuesday that the global drop in interest rates since the financial crisis is likely to persist and will make it harder for central banks to keep world economies healthy.

“Central banks will face daunting challenges in stabilizing their economies in response to negative shocks when interest rates are not far above their lower bound,” said Williams in an economic letter published by the bank. “Moreover, in a world of persistently very low interest rates, risks to financial stability may be greater than before.”

The Fed has raised its short-term interest-rate target just twice since the 2007-2009 financial crisis and recession, and many other global central banks have kept their rates pinned near zero or even below.

In a view that has gained traction among economists over the past year or two, Williams has argued that even as developed economies recover, interest rates are likely to top out at lower levels than before the crisis because economic growth is on a slower trajectory due to structural factors like aging populations. While before the crisis, the natural rate of interest in the UK, U.S, Europe and Canada was between 2 percent and 3 percent, it is now nearer to 0.25 percent, and it is showing no signs of perking back up.

Low so-called natural rates of interest mean that central banks will have less room to cut interest rates if economies are hit by shocks or recession.

That will force them to resort more often to policies like bond-buying that only a decade ago were seen as ground-breaking approaches to easing financial conditions, Williams said.

“What were once called ‘extraordinary’ policies — like zero or negative interest rates, forward guidance, and balance sheet policies — are likely to become the norm as central banks strive to achieve their macroeconomic goals,” Williams wrote on Tuesday.

Reporting by Ann Saphir; Editing by Andrea Ricci