Banks will still veer towards cheap money
Governments need to use their balance sheets to build productive assets
Again, in the case of the US, sharply lower interest rates accounted for 20 per cent of the growth of profits of non-financial corporations between 2007 and 2012. But there have been adverse effects on pension funds that must honour the promises they have made to members in defined-benefit schemes, and on insurance companies – particularly those that offered guaranteed nominal returns.
In the case of pension funds, reduced long-term yields are particularly unwelcome because they both lower returns and raise the present value of future liabilities. Many life insurers might be forced out of business if these rates persist. This is a crisis on a long fuse.
For households, the distributional consequences of ultra-low interest rates are more important than their aggregate effects. In the US, households with heads aged 35 to 44 are gainers from lower interest rates, while older households are losers. On average, the younger group gained $1,700 in annual net interest, while those over 75 lost $2,700.
Above all, the richest 10 per cent of Americans own about 90 per cent of all financial assets. Thus the main losers are relatively prosperous people who depend on interest income. At the same time, such people have also gained from huge rises in bond prices and strong equity markets, although McKinsey argues that low interest rates are not the most important factor behind equity gains.
This policy, however unpopular with some, is better than the available alternatives. Keynes even had a phrase for it – the “euthanasia of the rentier”. In a world of abundant savings, the available returns ought to be low; this is a consequence of market forces to which central banks are responding.
At present the world’s high propensity to save is not matched by a desire to invest. This is why fiscal deficits remain large and interest rates ultra-low. At the margin, additional savings are now useless.
Returns are being pushed even lower by the fact that central banks are seeking to prevent the bloated balance sheets created before the crisis from collapsing in an episode of mass insolvency.
There is, however, a puzzle. Why is private investment not stronger, given that the non-financial corporate sector is apparently so profitable?
Perverse managerial incentives are one explanation. The weakness of the financial sector is another. Then there is the vicious circle from weak demand, to sluggish investment, and back to weak demand. And to many, it seems sensible to postpone investment until the world is more predictable.
Low interest rates are certainly unpopular, particularly with cautious rentiers. But cautious rentiers no longer serve a useful economic purpose. What is needed instead are genuinely risk-taking investors.
In their absence, governments need to use their balance sheets to build productive assets. There is little sign that they will. If so, central banks will be driven towards cheap money. Get used to it: this will endure.
– Copyright The Financial Times Limited 2014