Why are interest rates so low?

Transcription

1 Why are interest rates so low? 18 November 214 Dieter Guffens Senior economist KBC Corporate Chief Economist Department

2 Overview Low interest rates in a historical perspective Driving forces of interest rates: why have interest rates been falling? Main take-aways 2

3 Historical perspective Short term interest rates Short term interest rates (Policy rates, in %) Fed Germany/ECB Short term interest rates UK (Policy rates, in %) 3 18/11/214 3

4 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) 4

5 Historical perspective Long term interest rates Long-term interest rates (1-year government bond, in %) Long-term interest rates UK (LT (1-year) government bond, in %) US Germany /11/214 5

6 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) Long term interest rates have broadly returned back to their normal level after the accident of the late 196s and 197s It is likely that the recent lower level will persist (New Normal) BUT we are now in a system of fiat money versus the gold standard previously 6

7 Driving forces: short versus long term rates Short term interest rates are mainly determined by monetary policy of the central bank Long term interest rates (bond yields) are determined by financial markets not under direct control of the central bank 7

8 Driving forces: two approaches First approach: nominal versus real interest rates Second approach: the slope of the yield curve the term premium in long term interest rates 8

9 Driving forces: long term interest rates First approach: nominal versus real interest rates Nominal interest rates = real interest rates + inflation (expectations) Our question becomes: what is driving inflation (expectations)? - both the LEVEL and the VOLATILITY matter! what is driving real interest rates? 9

10 Driving forces: inflation (expectations) Consumer price inflation (in %) US Belgium 1

11 Monetary reasons for low euro area inflation 25 2 Low credit growth (Credit to non-financial sector, annual change in %) US 2 18 leads to lower growth money supply (Broad money supply M2, annual change in %) US 15 euro area 16 euro area /11/214 11

12 ECB balance sheet major reason for low inflation 55 Balance sheet size in local currency (Jan 27 = 1) 4 Inflation divergence prominent sinds Q4 213 (headline inflation, annual change in %) 5 45 Fed ECB 4 Bank of Japan 3 35 Bank of England US euro area 12 18/11/214 12

13 ECB balance sheet major reason for low inflation 55 Balance sheet size in local currency (Jan 27 = 1) 3 Inflation expectations euro area low for long (based on inflation swaps, in %) 5 45 Fed ECB Bank of Japan Bank of England euro area US 15.5 Inflation target ECB & Fed /11/214 13

14 Driving forces: inflation (expectations) volatility 4. Standard deviation of CPI inflation (2 years moving window, in %) US Belgium 14

15 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) Long term interest rates have broadly returned back to their normal level after the accident of the late 196s and 197s It is likely that the recent lower level will persist (New Normal) BUT we are now in a system of fiat money versus the gold standard previously Since the 198s, the fall of inflation, and its volatility, played a major role in bringing down nominal yields The falling trend is over, but lower levels will persist for as long as central banks maintain their credibility of delivering price stability 15

16 Driving forces: real interest rate (Ex ante) real interest rates are the actual nominal interest rates minus the expected rate of inflation This definition is relevant for economic agents to make their ex ante investment and savings decisions Using actual inflation is relevant for ex post evaluation of investment decisions 16

17 Stylised facts In the 198s and early 199s, global monetary policy dominated the evolution of real interest rates During the rest of the 199s, fiscal consolidation in advanced economies was the main factor (EMU: Maastricht criteria, US: fiscal consolidation under President Clinton) In the 2s, the emerging markets (EM) saving rate rose strongly, together with increased demand for safe assets from foreign central banks (EM) Since global financial crisis, investment in advanced economies declined markedly Financial regulation Most recently, monetary policy again played a crucial role 17

18 Stylised facts: US In the 198s and early 199s, global monetary policy dominated the evolution of real interest rates During the rest of the 199s, fiscal consolidation in advanced economies was the main factor (EMU: Maastricht criteria, US: fiscal consolidation under President Clinton) In the 2s, the emerging markets (EM) saving rate rose strongly, together with increased demand for safe assets from foreign central banks (EM) Since global financial crisis, investment in advanced economies declined markedly Financial regulation Most recently, monetary policy again played a crucial role In LT perspective US real yields not unusually low (1 year government bond yield minus actual inflation in %) 18

19 Stylised facts: UK In the 198s and early 199s, global monetary policy dominated the evolution of real interest rates During the rest of the 199s, fiscal consolidation in advanced economies was the main factor (EMU: Maastricht criteria, US: fiscal consolidation under President Clinton) In the 2s, the emerging markets (EM) saving rate rose strongly, together with increased demand for safe assets from foreign central banks (EM) Since global financial crisis, investment in advanced economies declined markedly Financial regulation Most recently, monetary policy again played a crucial role In LT perspective UK real yields not unusually low (1 year govy yield in %) 19

20 Impact of monetary policy Quantitative Easing (QE) and real interest rates Real interest rates clearly influenced by monetary (quantitative) expansion US QE, ECB LTROs Tapering effect Japanese QQE Recently, Fed tightening expectations have been pushed further away into the future. Expectations of some QE by ECB have been increasing Monetary policy important driver of real interest rates (1 year government bond yields minus swap implied inflation expectations, in %) Germany US Japan 2 Source: IMF

21 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) Long term interest rates have broadly returned back to their normal level after the accident of the late 196s and 197s It is likely that the recent lower level will persist (New Normal) BUT we are now in a system of fiat money versus the gold standard previously Since the 198s, the fall of inflation, and its volatility, played a major role in bringing down nominal yields The falling trend is over, but lower levels will persist for as long as central banks maintain their credibility of delivering price stability Real long term interest rates are not exceptionally low in historical perspective, but also have been falling since the 198s. The main factors are monetary policy (8s), fiscal consolidation (9s), EM saving (2s) and declined investment in advanced economies and accommodating monetary policy since 28 21

22 Driving forces: long term interest rates Second approach: the term structure of interest rates Principle: long term interest rates are the combination of current short term rate and expected future short term rates this is the expectation hypothesis of the term structure of interest rates (yield curve) theoretically, this would be true for a purely risk-neutral investor, i.e. who is completely indifferent towards uncertainty or volatility In practice, long term interest rates also contain a risk premium called term premium (positive or negative) Within this framework, monetary policy can directly influence long term yields by setting the current policy rates indirectly influence long term yields by influencing - expected future policy rates ( = forward guidance ) - the term premium ( = quantitative easing, designed to reduce this premium) 22

23 Term structure of interest rates Slope of yield curve 6 4 Slope US yield curve (1 year rate minus policy rate, in %) Rate hikes expected Slope EMU yield curve (1 year rate minus policy rate, in %) No rate hikes expected slope average -1 slope average /11/214 23

24 Term premium Some drivers likely to remain in place Term premium can be affected by Increasing risk aversion (lower) Financial regulation raising the amount of required riskless assets to be held (lower) Bigger need for riskless assets as collateral for repo operations (lower) Quantitative monetary policy, by buying on the long end of the yield curve (lower) Foreign central banks increasing their FX reserves (lower) Financial crises: default risks (higher) US term premium estimation for 1 year Treasury (in %, estimation by Fed) 24 18/11/214 24

25 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) Long term interest rates have broadly returned back to their normal level after the accident of the late 196s and 197s It is likely that the recent lower level will persist (New Normal) BUT we are now in a system of fiat money versus the gold standard previously Since the 198s, the fall of inflation, and its volatility, played a major role in bringing down nominal yields The falling trend is over, but lower levels will persist for as long as central banks maintain their credibility of delivering price stability Real long term interest rates are not exceptionally low in historical perspective, but also have been falling since the 198s. The main factors are monetary policy (8s), fiscal consolidation (9s), EM saving (2s) and declined investment in advanced economies and accommodating monetary policy since 28 Long term interest rates are also low because of low policy rates (via the term structure of the yield curve) and because of the compressed term premium These factors are unlikely to be part of the longer term New Normal 25

26 The secular stagnation approach Hansen, Summers, Krugman and others This approach regards the current environment of low inflation, near-zero short term and low long term interest rates as a classic case of insufficient macroeconomic demand This idea corresponds to a Keynesian style liquidity trap It is related to the paradox of thrift Economic stagnation is seen as what Keynes described as a macro-economic equilibrium with underemployment Stagnation theories were developed during the Great Depression and are based on the work of Alvin Hansen (1938). Stagnation is caused by a slowdown of technological innovation and/or population growth. The economic recovery during World War II was still consistent with the Keynesian concept of macro-economic demand deficiency. However, the ongoing economic expansion after WWII was not consistent anymore with stagnation theory 26

27 The secular stagnation approach Hansen, Summers, Krugman and others The present day version of the secular stagnation theory (Summers, Krugman) is a version of the Keynesian liquidity trap. There is excess liquidity in the economy, which is not met by sufficient demand by investors, because they lack enough profitable investment opportunities. Therefore, the market clearing real interest rate to absorb all excess savings is apparently negative and more so than currently feasible. Summers suggests that the real short term interest rate consistent with full employment may be -2% to -3%. The proposed solution to end this demand deficiency are e.g. public investments to absorb excess savings at seemingly no economic opportunity costs (since they lead to higher economic growth). 27

28 versus monetary overkill? The Austrian School (Von Hayek, Mises, etc, ) According to the Austrian School In the long term, the natural real interest rates is at a level that balances savings and investments at full employment. If economic (monetary) policy pushes rates below their natural level, investments are stimulated and savings discouraged. Economic growth accelerates, until inflation and interest rates rise again. Marginal investment projects fail. Economic growth resumes only after all overinvestments have been eliminated. If (monetary) policy tries to counter this by artificially low rates, the production structure remains inefficient with low economic growth. Monetary policy increasingly expansionary in times of crises (Fed fund target rate minus actual core CPI inflation, in %) Real Fed fund target

29 versus monetary overactivism? The Austrian School (Von Hayek, Mises, etc, ) Since mid-198s, monetary rather than fiscal policy was the tool of choice to stabilise the business cycle (the Great Moderation) Is Chinese overinvestment (in line with Fed s QE s and FX pegging) the most prominent illustration of inefficient overinvestment? An increasingly more expansionary monetary policy has been accompanied by an ever-weaker economic recovery. One might conclude that the medicine against hangovers has become less effective after so many wild parties. (Mayer) Monetary policy increasingly expansionary in times of crises (Fed fund target rate minus actual core CPI inflation, in %) Real Fed fund target

30 Main take-aways Short term (policy) rates are exceptionally low by historical standards (not New Normal) Long term interest rates have broadly returned back to their normal level after the accident of the late 196s and 197s It is likely that the recent lower level will persist (New Normal) BUT we are now in a system of fiat money versus the gold standard previously Since the 198s, the fall of inflation, and its volatility, played a major role in bringing down nominal yields The falling trend is over, but lower levels will persist for as long as central banks maintain their credibility of delivering price stability Real long term interest rates are not exceptionally low in historical perspective, but also have been falling since the 198s. The main factors are monetary policy (8s), fiscal consolidation (9s), EM saving (2s) and declined investment in advanced economies and accommodating monetary policy since 28 Long term interest rates are also low because of low policy rates (via the term structure of the yield curve) and because of the compressed term premium These factors are unlikely to be part of the longer term New Normal Secular stagnation is possible, but monetary overactivism is also a plausible explanation for the decreasing (real) interest rates during the past decades 3