Low rates reflect slower economic activity and weakness rather than strength; they have also reduced the political appetite for much needed policy changes
Isaac Newton believed that truth is found in simplicity, not in multiplicity and confusion. Based on current interest rate policies, central bankers in developed markets clearly believe in the opposite.
Since Lehman Brothers left the mortal coil, there have been more than 600 rate cuts.
Over the same period, central banks have injected over $12 trillion under quantitative easing (QE) programmes into money markets. Over $26 trillion of government bonds are now trading at yields below 1 percent with over $6 trillion currently yielding less than zero percent.
These policies, according to policymakers, have been crucial to the ‘recovery’.
Financial market valuations have increased but remain reliant on low rates and abundant liquidity. The effect on the real economy is less clear. Policymakers argue that without these actions to support growth, employment and investment would have been weaker It is a proposition that is, of course, impossible to test.
Now there is increasing confusion about future interest rate policy. For the last 12 months, US Fed Chair Janet Yellen has prevaricated about increasing interest rates. Until the 25 basis points increase in December 2015, the Fed did not have a rate increase for 112 months—the longest since World War II.
Markets expect that stronger US employment numbers and an improving economy will drive rate rises in 2016. Puzzlingly, the Fed chair has hinted that more QE or negative interest rates are possible, should conditions dictate. There is little agreement among the Fed governors about the appropriate policy path.
Yellen also has to worry about non-terrestrial matters. Representative Brad Sherman recently told Yellen that God does not want her to raise interest rates until May: “If you want to be good with The Almighty, you might want to delay until May. God’s plan is not for things to rise in autumn, that is why it is called Fall.”
The Fed’s OMC (open market committee) is now referred to commonly as the Open Mouthed Committee or, more charitably, the Open Minded Committee.
Everyone else is cutting rates
In Europe, the European Central Bank (ECB) President Mario Draghi has hinted that he will consider lowering rates further. European central banks are already operating negative deposit rate policies. The ECB is at minus 0.3 percent, Swiss policy rate is minus 0.75 percent and Sweden’s policy rate is minus 0.35 percent.
In October 2015, Italy sold two-year debt at a negative yield for the first time. Investors are now paying to lend to a country which has one of the highest debt-to-GDP ratios in the world. It is also a country synonymous with pizza, pasta, political gridlock and fiscal indiscipline.
The Bank of England has suggested that the UK’s interest rates may not increase in 2016 or even in 2017.
The Bank of Japan (BoJ) has promised additional easing if necessary “without hesitation”. The Japanese have even rebranded QE as QQE (quantitative and qualitative easing). The qualitative is central banks talking about easing.
The People’s Bank of China, China’s central bank, cut benchmark interest rates six times in the course of a year to a record low of 1.5 percent in a bid to support an economy which is forecast to grow at its slowest annual rate in 25 years.
Further interest rate cuts are forecast in Australia, New Zealand and also many emerging countries.
Central bankers argue that the case for increasing rates is limited. Despite record levels of monetary stimulus, growth remains lacklustre. Forecasts of economic activity have seen regular downgrades over the last 2-3 years. Disinflation and deflationary pressures remain, with low commodity, especially energy, prices likely to continue. Overcapacity in many industries limits the ability to increase prices.
Even in the US, where the economy is performing better than other developed countries, wage pressures are limited. Fed Chair Yellen’s concerns about tight labour markets miss the point that the market is now increasingly global. There are significant surplus labour forces in other nations which can be accessed through global supply chains.
Central bankers dismiss criticism that the policies are, at best, ineffective and, at worst, damaging.
Low rates have created problems for savers and retirees around the world. Pension funds are in trouble with rising levels of unfunded liabilities. German Finance Minister Wolfgang Schaeuble has drawn attention to the increasing solvency problems of insurance companies and retirement funds in an environment of low or negative rates.
(This story appears in the 19 February, 2016 issue of Forbes India. To visit our Archives, click here.)