The low-yield world is not ending any time soon
Monetary policy Low interest rates don't just reflect low global growth - they are helping to keep it that way.
Why are interest rates so low? And how long will they stay that way?
The Bank of International Settlements (BIS) notes in its annual report released this week: "Interest rates have never been so low for so long. Between December 2014 and end-May 2015, on average around $US2 trillion ($2.6 trillion) in global, long-term sovereign debt, much of it issued by euro area sovereigns, was trading at negative yields. At their trough, French, German and Swiss yields were negative out to a respective five, nine and 15-year yields."
The yields nominated above are unprecedented and disconcerting. Arguably, that has already happened. Current low yields are indicative of a much broader malaise than that which has struck Greece.
The BIS report suggests that, without a major overhaul of global monetary practices, the current malaise is likely to deteriorate further and could result in the impoverishment of many who have assiduously saved to finance a comfortable retirement. Emerging market economies (EME) that have borrowed heavily in US dollar-denominated loans are seen as particularly vulnerable.
Do not take comfort if you have no direct exposure to the emerging markets, because the EMEs' heft in the global economy has soared since the Asian crisis, from about onethird to almost half of global GDP in purchasing power terms. China is a case in point. At the end of 2014, it was the world's eighth-largest borrower of the $US1 trillion in crossborder bank claims, double the amount outstanding just two years before.
Greece looks to be a prospective case study of the social, political and financial implications of a mismanaged monetary and financial system.
It is the contention of the BIS that the malaise that has enfeebled financial systems reflects the failure to come to grips with slower-moving financial booms and busts that leave deep and enduring scars. This runs the risk of entrenching instability and chronic weakness. Domestic policy regimes have been too narrowly concerned with stabilising short-term output and inflation.
The BIS sees the domestic preoccupation of central banks with inflation as the explanation for persistently low-interest rates.
An economy's interest rate structure is effectively built on the short-term policy floor set by the central bank. In addition, central banks have influence on the long term through signals about how they will set short-term rates and, increasingly, through large-scale purchases along the maturity spectrum.
Market participants set deposit and loan rates and through their portfolio choices help determine long-term market rates. Market participants address many factors as to where the longer-term rate should sit. Not surprisingly, expectations of what the central bank will do rank highly among the factors taken into account.
The BIS report describes the conventional process of the interest rate determination and then poses and answers its own question: "Are the interest rates that prevail in the market actually equilibrium rates? Take first the short-term rate, which central bankers set.
"When we read that central banks can have only a transitory impact on inflation-adjusted short-term rates, what is really meant is that, at some point, unless central banks set them at their 'equilibrium' level, or sufficiently close to it, something 'bad' will happen. "Exactly what that 'bad' outcome is will depend on one's view of how the economy works. In the prevailing view - one embedded in the popular 'savings glut' and 'secular stagnation' hypothesis - the answer is that inflation will either rise or fall, possibly into deflation.
"Inflation provides the key signal and, its behaviour depends on the degree of economic slack."
But slack is difficult to measure in practice. It is subordinate to inflation. It is the BIS contention that: "The very low interest rates that have prevailed for so long may not be the 'equilibrium' ones, which would be conducive to sustainable and balanced global expansion.
"Rather than just reflecting the current weaknesses, low rates may in part have contributed to it by fuelling costly booms and busts."
The BIS report points out that financial bubbles and busts tend to be both larger in scale and longer in duration than other similar episodes. This elasticity of finance results in too much debt, too little growth and excessively low interest rates.
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