Banks will still veer towards cheap money
Governments need to use their balance sheets to build productive assets
The Gherkin and St Helens stand at the heart of the City of London. Photographer: Chris Ratcliffe/Bloomberg
High-income economies have had ultra-cheap money for more than five years. Japan has lived with it for almost 20. This has been policymakers’ principal response to the crises they have confronted. Inevitably, a policy of cheap money is controversial. Nonetheless, as Japan’s experience shows, the predicament may last a long time.
The highest interest rate charged by any of the four most important central banks in the high-income economies is 0.5 per cent at the Bank of England. Never before this period had the rate been below 2 per cent. In the US, the euro zone and the UK, the central bank’s balance sheet is now close to a quarter of gross domestic product. In Japan, it is already close to half, and rising.
True, the Federal Reserve is tapering its programme of asset purchases, and there is talk that the Bank of England will soon tighten policy. Yet in the euro zone and Japan the question is whether further easing might be needed.
These unprecedented policies are needed because of the chronic deficiency of global aggregate demand. Before the wave of post-2007 crises hit the world economy, this deficiency was met by unsustainable credit booms in a number of economies. After the crises, it led to large fiscal deficits and a desperate attempt by central banks to stabilise private balance sheets, mend broken credit markets, raise asset prices and ultimately reignite credit growth.
These policies have succeeded in lowering the cost of borrowing. This has made it easier to bear both the huge quantities of private debt inherited from before the crisis, and the public debt that has been accumulated in its aftermath. A report from the International Monetary Fund, published in October 2013, concluded that the bond purchase programmes from November 2008 lowered US 10-year bond yields by between 90 and 200 basis points. In the UK, bond-buying that began in 2008 lowered them by between 45 and 160 basis points. In Japan, similar interventions from October 2010 lowered rates by about 30 basis points, although Japanese yields started from a lower level.
Lower interest rates have also had a significant effect on the distribution of income. A study by McKinsey Global Institute published at the end of last year shows large shifts in income from net creditors to net debtors. In general, governments and non-financial corporations have gained. Insurance companies, pensions providers and households have been among the losers.
Banks are in an intermediate position. US banks have gained because their interest margins have risen. Euro zone banks have lost because their interest margins have been squeezed. UK banks have also suffered small losses.
Some of the details are significant. Governments are winners not only because the interest rates they pay are lower than before the crisis, but because quantitative easing has monetised a substantial portion of government long-term debt. Thus, in the case of the US, the Federal Reserve transferred $145 billion in gains from quantitative easing to the government between 2007 and 2012.
This is in addition to the $900 billion the government saved over the same period through lower interest payments. In the UK, quantitative easing produced gains of $50 billion for the exchequer in addition to $120 billion in interest savings.