Are Low Rates Natural?

Transcription

1 Are Low Rates Natural? Charles Bean London School of Economics Monetary and Financial Policy Conference London 25 September 2015

2 Questions and outline Questions: Why are (real safe) interest rates so low? Will they persist? What might be the consequences and policy implications? Outline Recent and historical facts Possible causes Possible consequences Possible policy responses 2

3 Per cent International 10-year spot yields US UK Germany Japan Source: Barclays, Bloomberg mid-yields 4

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5 World 10-year risk-free real interest rate Unweighted "World" US TIPS * World real interest rate is an unbalanced simple average of G7 ex Italy 10-year real yields. Sliced UK indexed gilts were used to proxy world real yields from From , World rates were calculated using a simple average of spliced US 10-year TIPS and UK IGs. From , World rates were calculated using a simple average of spliced 10-year US, UK, Canada, Japan, and France indexed bonds. From , World rates were calculated using a simple average of spliced 10-year US, UK, Canada, Japan, France, and Germany. Source: Barclays, Bloomberg mid yields 6

6 Average real Treasury-bill rates, Advanced Economies Emerging Economies Source: Reinhart and Sbrancia (2014). Advanced economies are: Australia, Belgium, Canada, France, Germany, Greece, Ireland, Italy, Japan, New Zealand, Sweden, United States, and United Kingdom. Emerging economies are: Brazil, Egypt, India, Korea, Malaysia, Mexico, Philippines, South Africa, Turkey and Venezuela. 7

7 Estimates of US short-term and long-run World real interest rates Source: Hamilton, Harris, Hatzius and West (2015) The Equilibrium Real Funds Rate: Past, Present and Future 8

8 300 years of UK nominal and real long-term yields Consol yield Ex ante real consol yield Source: Bank of England Historical database ( and own calculations 9

9 Global market for loanable funds Real interest rate I I O S S S O I S I Investment, Savings 10

10 Savings and investment shares (% of GDP) Source: IMF WEO database 11

11 Implications of interest insensitivity Saving is interest insensitive Investment is interest insensitive Real interest rate I S Real interest rate I S I O O S O I S O I S S I Investment, Savings Investment, Savings 12

12 Causes: Propensity to save Higher propensity to save (Bernanke) Demography High savings in China Chinese financial integration Income inequality Post-crisis effects 13

13 Past and projected population shares World (ex China) China Projected Middle Old Difference Source: United Nations Projected Middle Old Difference 15

14 Demographic pressure and savings propensities Savings/GDP Difference between population shares of middle-aged and old Source: United Nations and IMF WEO database Note: Observations are averages for the US, China, Euro area (Germany, France, Italy, Spain, and Ireland), Japan, UK, India, Korea, Brazil, Mexico, and Russia over the following 5-year periods: , , , and

15 Effect of financial integration 17

16 UK savings rates by household type (a) Source: Living Costs and Food (LCF) survey. (a) (b) Saving ratios calculated using the average consumption and disposable income levels for each group of households. Numbers in parentheses show their share of total income in High-debt mortgagors are defined as having outstanding mortgage debt of more than twice their annual disposable income. All other mortgagors are low debt. 20

17 Causes: Propensity to invest Lower propensity to invest (Gordon, Summers) Demographics Slower TFP growth Shift in capital intensity of production Falling relative price of capital goods Post-crisis effects 21

18 Working age (20-64 years) population growth (5-year averages) World More developed Less developed Source: UN database 22

19 It is not so easy to foresee the future Heavier-than-air flying machines are impossible. (Lord Kelvin, President of the Royal Society, 1895) Everything that can be invented has been invented. (Charles Duell, Commissioner, US Office of Patents, 1899) The wireless music box has no imaginable commercial value. Who would pay for a message sent to nobody in particular? (David Sarnoff Associates, 1920s) Who the hell wants to hear actors talk? (Head of Warner Brothers, 1927) I think there is a world market for maybe five computers. (Thomas Watson, Chairman of IBM, 1943) There is no reason anyone would want a computer in their home. (Ken Olsen, Chairman of DEC, 1977) 23

20 Causes: Asset demands/supplies Higher demand for safe assets Emerging-economy reserve accumulation Heightened disaster risk (Barro) Tightening of bank liquidity regulation Central bank asset purchases (QE) Lower supply of safe assets (Caballero-Farhi) Crisis revealed many AAA-rated ABS not safe Euro-area debt crisis revealed some advancedeconomy sovereign debt not safe But lot of issuance by safe sovereigns too! 24

21 Safe sovereign and equity yields % 10 United States 8 10 % 8 United Kingdom Equities* 10-year TIPS -2 Equities* 10-year indexed gilts *Leverage-adjusted inverted Price-Earnings ratio. Source: Bank of England, following Broadbent (2014) Monetary policy, asset prices and distribution. 28

22 Causes: Asset demands/supplies Higher demand for safe assets Emerging-economy reserve accumulation Heightened disaster risk (Barro) Tightening of bank liquidity regulation Central bank asset purchases (QE) Lower supply of safe assets (Caballero-Farhi) Crisis revealed many AAA-rated ABS not safe Euro-area debt crisis revealed some advancedeconomy sovereign debt not safe But lot of issuance by safe sovereigns too! 31

23 Decline in supply of safe assets US$ trn % of World GDP US sovereign debt o/w held by Federal Reserve German & French sovereign debt Italian & Spanish sovereign debt US MBS and ABS Safe assets Source: Caballero and Farhi (2014) On the role of safe asset shortages in secular stagnation. 32

24 Prospects for natural real rate Reasons to expect some rise in natural real rate Demographics have just turned round Dwindling headwinds from financial crisis But yield curve very flat and distribution of short rates truncated on down side market attaches very low weight to rise Prudent for policymakers to consider consequences of persistently low natural real rate 33

25 United States Spot and forward real yields United Kingdom Real 10 yr spot Real 10-year 10-years forward Real 10-year spot Real 10-year 10-years forward Source: US Federal Reserve Board of Governors and Bank of England 34

26 Consequences: Monetary policy Lower bound (LB) Bites more frequently (>15% of time with natural real rate of ½% v 5% of time at 2½%) What is lower bound? Substitution into cash likely to occur once official rates < -½% Central banks not out of ammunition at LB Forward guidance: only relevant at short end Quantitative easing: evidence suggests QE1 (US & UK) reduced yields by 1pp, but Less effective with normal markets & flat yield curve Extensive use takes central bank into political territory Effect on exchange rates/capital flows can create international tension 35

27 Consequences: Financial stability Persistently low real rate makes retirement provision more expensive; encourages move to higher-yielding risky assets OK if goes into equities and leads to more investment May be less benign if leads to (leveraged) acquisition of existing real estate assets Impact on markets Relative-performance benchmarks for fund managers, etc, slow to adjust (leveraged) search for yield Investors willing to pay for a +ve return; less willing to pay for a -ve return (money illusion) some business models unviable unless returns somehow levered up Bottom line Economy more open to financial boom-busts Corollary: worse risk-return trade-off for monetary policy 37

28 Cov-lite and second-lien leveraged loans outstanding $600B $500B $400B $300B $200B $100B $0B Covenant-Lite Second-Lien 39

29 Policy responses Can we increase effectiveness of monetary policy? Raise inflation target to 4%? Loses benefit of stable prices heuristic and may lead to rise in inflation risk premium More exotic options: eliminate cash; charge interest on cash; break link between cash and reserves Relaxing LB constraint also worsens risks to financial stability Right to assign monetary policy to inflation control and (macro)prudential policy to maintaining financial stability But lot of weight placed on untried policy machinery Ensure financial system robust (bank capital, resolution regimes) Monetary policy makers should try to avoid pushing asset prices and credit above levels that would be sustainable in normal times Better to raise natural rate through structural and fiscal policies Where debt high, discourage saving rather than encourage borrowing 40