1. Some key global macro issues in a
European perspective:
secular stagnation, financial repression
and safe assets
Richard Portes
London Business School and CEPR
II Europe - Latin America Economic Forum
Paris, 20 May 2014
2. The problem
Long-term low real interest rates
So it’s hard for investors to get yields they had
previously achieved – 8% targets won’t come back
Hence ‘search for yield’ and ‘safe assets’, some asset
price bubbles, fed also by monetary policy trying to
get rates down to stimulate the economy
But maybe even the rates we observe aren’t low
enough, that is…
…maybe the ‘equilibrium’ real interest rate has fallen
substantially – and then monetary policy, at least, is
inadequate to get more investment and growth 2
3. Road map
Competing stories about low real interest rates
Financial repression: what? why? how?
Are government debt problems really leading the
authorities to financial repression? – unlikely, we think
Undesirable effects of sustained low interest rates
Are low rates a consequence of a safe asset shortage?
The evidence says no
So maybe we really have entered an era of ‘secular
stagnation’ – or maybe it’s something else
It matters! – are loose monetary policies and low
rates likely to persist? 3
4. Competing stories of long-term low
real interest rates
‘Secular stagnation’ (Summers 8 November 2013)
- the equilibrium real interest rate has fallen to -3%, say,
and monetary policy can’t get us there with inflation at 1-
2% (the ‘target’ of Fed, BoE, ECB, BoJ)
- so ‘savings glut’ (Bernanke) – rather, underinvestment
and low growth, but also asset price bubbles, as central
banks ease, trying to reach ‘equilibrium’ real rate
- when they decide to reverse, asset prices will fall
sharply, because markets realise slow growth will continue
Financial repression (Reinhart and Sbrancia)
Low policy rates because financial crisis lingers
Shortage of safe assets (Caballero et al.) 4
5. Financial repression: what and why?
Governments and central banks – ‘non-market
forces’ – keep interest rates ‘artificially low’
This taxes savers to pay for government debt
reduction
And if real interest rates are less than growth
rates, the government can ‘grow out of debt’
5
6. How can government debt/GDP fall?
Default – highly unlikely, except for eurozone
peripherals
Surprise inflation – hard to engineer
Growth rates rise – we can hope so!
Primary fiscal surpluses – moving that way
But if growth remains low, it’s hard to get
primary fiscal surpluses
Are governments then tempted to impose
financial repression?
6
7. Financial repression: how?
Direct ceilings on nominal interest rates, especially
for depositors
Central bank buys government bonds, pushing
nominal rates down
Inducing inflation lower real interest rates
Financial regulation pushes savers to hold more
government bonds
Capital controls may keep savers from exiting and
thereby keep domestic yields down
7
8. But what is ‘artificially low’?
In a slump, the nominal interest rate hits the zero
lower bound, and it’s still not an ‘equilibrium’ rate – it
is still too high to be consistent with full employment
That has been the problem in the US, UK, Euro area,
and Japan
The secular stagnation story says this may be the
‘new normal’
So nothing ‘artificial’ about low interest rates, not a
sign of financial repression
8
9. No significant financial repression in
DM economies – in particular, Europe
No ceilings on interest rates
Low inflation, and inflation expectations are below CB
targets for ECB and Japan, at target for US and UK
No capital controls
Real interest rates not ‘historically low’ for US and UK
Yes, new regulatory measures – the liquidity coverage ratio
and Basel III – push banks to hold more government bonds
But the authorities now realise that this is mistaken
- can’t keep on pretending government bonds are risk-free
- mustn’t increase deadly nexus between banks and sovereigns
9
10. The historical record
Reinhart and collaborators claim that much of the reduction
in government debt/GDP since 1950 in a large sample of
countries was due to financial repression – i.e. ‘artificially
low’ interest rates
But Scott and collaborators claim precisely the opposite for
G7 countries 1960-2005
And Goldman Sachs seems to side with Scott et al.
10
11. Primary balance is important throughout, (r – g) in early period, the latter
mainly because of high g
12. So don’t blame financial repression
for low interest rates
It wasn’t the main factor in the postwar debt
reduction
Nor is it likely to be the way advanced
countries deal with their debt problems going
forward
Still, we do have low nominal and real rates –
and if prolonged, they may have undesirable
effects
12
13. Consequences of low interest rates
Transfer from creditors to debtors – to the extent
that monetary policy affects real rates, it redistributes
Households with variable-rate mortgages benefit,
those holding endowment policies and purchasers of
annuities suffer
And low nominal rates pose problems for institutions
with fixed nominal obligations – indeed, their
solvency may be threatened by accounting rules that
assume the low nominal rates will go on forever
13
14. Potential dangers
Asset price bubbles? No clear evidence.
‘Search for yield’? – yes!
Is that a problem? Only if you want ‘risk-free’ assets
that pay substantial real yields
But such assets haven’t really been available for most
of the post-1960 period – although some investors,
misled by ratings, thought some assets were ‘safe’
that turned out to be highly risky
That leads to the second part of the story:
Is there or will there be soon a shortage of
reasonably safe assets?
14
15. Maybe – and if so, we should be
scared! (say the FT and others)
FT Alphaville headline 5 December 2011: ‘The
decline of “safe” assets’, presenting ‘the most
important chart in the world’, titled ‘Shrinking
universe of “safe” assets in the primary reserve
currencies’
It gets worse:
Financial Times headline 27 March 2013: ‘Global
pool of triple A status shrinks 60%’
15
16. ‘The world has a shortage of financial assets’
(Caballero 2006) – and it will get worse
‘In the future, there will be rising demand for
safe assets, but fewer of them will be available…’
(IMF Global Financial Stability Report April 2012)
16
17. Preliminary question
Where to draw the line? No asset is truly safe :
not in default risk (CDS spread on US Treasuries 5-yr at
1.1.09 was 67 bps, long before August 2011 debt-limit scare)
nor liquidity risk (3-month US Treasuries stopped trading for
30 minutes at peak of post-LTCM turmoil, on 5.10.98)
nor inflation risk (US inflation went well over 10% in 1979-80)
nor exchange-rate risk (the dollar depreciated 50% against
the DM from Feb 1985 to Oct 1987)
There is a continuum that requires judgment or reference to
the markets - hence difficulties with the data
17
18. Safe asset shortage, search for yield,
and financial instability
The claim: it is the shortage of safe assets that pushed real
interest rates down to ‘historically low’ levels pre-crisis,
hence investors needing yield went into excessively risky
assets – and it’s happening again!
Further consequences: global imbalances and asset price
bubbles
Shortage of safe assets led private sector to create ‘private
label’ safe assets that weren’t really safe but were certified
by the ratings agencies and easily marketed
Bernanke (2013), Kocherlakota (2013), and the IMF in
GFSR 2012 share the concern that safe asset shortages will
lead to financial instability (volatility jumps, herding, cliff
effects…) 18
19. Evidence: Effects on interest rates?
Real interest rates did fall from 1980s and early 1990s to
levels that seemed historically low in 00s – but they weren’t,
because real interest rates were much the same in 1960s
and lower in 1970s.
Hard to claim a shortage of safe assets both pre- and post-
1971!
So was it ‘financial repression’? Doubtful: that would block
cross-border transmission, but there was high co-movement
of advanced economy and emerging market spreads 1960-
1980.
19
20. Evidence
Asset price bubbles – really? is there agreement
on identifying asset price bubbles before they
burst? Where are the bubbles now?
Interest rates and spreads – in fact, long-term
US and UK government bond interest rates aren’t
‘historically low’, nor are spreads of corporate
bonds
Volumes of ‘safe’ assets – how to identify supply
and demand? What is ‘safe’?
20
25. So where is the search for (high) yield – as in 1998?
25
26. ‘The most important chart in the world…’
Credit Suisse 2012 Global Outlook
26
27. …unless it’s this one – with a very different message
H. Blommestein, Bloomberg Brief, 3 January 2013 27
28. Nor does Goldman Sachs buy ‘shrinkage’…
Global
Economics
Weekly
27 June 2012
…and they have a nice idea: define ‘safe assets’ by positive yield correlation
with risk appetite. Then US Treasuries, non-Euro area G10, German, Dutch,
Finnish, US agencies and AAA-rated covered bonds are still treated as ‘safe’.28
29. So it’s hard to find the ‘safe asset shortage’
Hard indeed to define ‘safe’
Role of ratings is dubious at best
GFSR bravely says ‘asset safety should not be viewed
as being directly linked to credit rating’ but does it all
the same, like everyone else – yet downgrading of
US, UK, France had no effect on 10-year yields
True, sovereign nominal yields are low
That’s not because of QE: numbers aren’t big
enough, and no QE for Bunds – yet Bund yields are
well below those on 10-year US Treasuries and UK
gilts 29
30. So again, why are long rates so low?
Either excess demand for safe assets
or weak demand for funds from private sector
plus extended expectations of Zero Interest Rate
Policy
The latter accords with both theory and the data
The question remains whether the low policy
rates are cyclical (still not out of financial crisis)
or a response to ‘secular stagnation’
The big issue: What will the central banks think,
and how will that affect their policies? 30
