What’s New About Today’s Low Interest Rates?

Carmen Reinhart.

Newsart for What’s New About Today’s Low Interest Rates?

CAMBRIDGE – A day seldom passes without articles appearing in the financial press pondering why interest rates have remained so low for so long. This is one of those articles. So let’s start by clarifying whose and which interest rates are low and what is and isn’t novel or unprecedented.
Interest rates in emerging and developing countries are importantly affected by what happens in the world’s largest economies, and the ongoing multi-year low-interest-rate cycle has its roots in the United States, Europe, and Japan. Low rates are predominantly the advanced economies’ “new normal.”
Interest rates (short and long maturities) had been trending lower in most of the advanced economies (to varying degrees) since the 1980s, as inflation also fell sharply. In the years prior to the 2008-2009 financial crisis, former US Federal Reserve Chairman Ben Bernanke repeatedly stressed the role of a global “saving glut” (notably in China) to explain lower rates.
More recently, former US Treasury Secretary Lawrence Summers argued that “secular stagnation,” manifested in sustained lower investment and growth in many advanced economies, has been a major force driving down rates. These hypotheses (which are not mutually exclusive) are especially helpful in understanding both why rates were drifting lower prior to the crisis and why the downturn has persisted.
The financial crisis ushered in a new source of downward pressure on interest rates, as monetary policy turned emphatically accommodative. The US Federal Reserve led the charge among central banks, acting fast and aggressively in response to the global turmoil, by relying on a near-zero policy rate and massive asset purchases (so-called quantitative easing). In the post-crisis era, the Bank of Japan and the European Central Bank – both under new leadership – followed suit. Negative nominal policy interest rates are a more recent phase of these policies.
Since 2010, I have been emphasizing the key role played by policy in keeping rates low in a post-crisis era characterized by large overhangs of public and private debt in the advanced economies and a tendency toward deflation. This combination potentially weakens financial, household, and government balance sheets.
In other words, interest rates have been low, and remain low, because policymakers have gone to great lengths to keep them there. The policy mix has combined a “whatever it takes” approach to keeping policy interest rates low (and sometimes negative) with a heavier dose of financial regulation.
If central banks were to act credibly to raise interest rates substantially (for whatever reason), they would not lack the tools or ability to do so. In this unlikely scenario, market expectations would adjust accordingly and rates would rise (saving glut and secular stagnation notwithstanding).
The behavior of real (inflation-adjusted) interest rates helps clarify the role of the post-crisis monetary-policy shift. As shown in the figure below, which plots the share of advanced economies with negative long-term interest rates (ten-year treasuries yielding less than the rate of inflation) from 1900 to 2016. In the run-up to the crisis, there are no recorded negative real returns on government bonds; since the crisis, the incidence of negative returns increases and has remained high. Of course, the share of countries with negative short-term treasuries (not shown here) is even higher since 2009.
advanced economies with negative long-term interest rates
But the figure also shows that the 2010-2016 period is not the first episode of widespread negative real returns on bonds. The periods around World War I and World War II are routinely overlooked in discussions that focus on deregulation of capital markets since the 1980s. As in the past, during and after financial crises and wars, central banks increasingly resort to a form of “taxation” that helps liquidate the huge public- and private-debt overhang and eases the burden of servicing that debt.
Such policies, known as financial repression, usually involve a strong connection between the government, the central bank, and the financial sector. Today, this means consistent negative real interest rates – equivalent to an opaque tax on bondholders and on savers more generally.
So if a prolonged period of low and often negative real interest rates is not unprecedented, where is the novelty? More often than not, negative real rates were accompanied by higher inflation (as during the wars and the 1970s) than what we observe today in the advanced economies. Even when average inflation was modest (as in the 1950s and 1960s), it was still more volatile.
In the 1930s, in the midst of economic depression and sharp deflation, US Treasury bills sometimes traded at negative yields (and real returns were still positive). In today’s low-inflation or outright deflationary environment, central banks may need negative policy rates (this is the novelty part) to produce negative real rates. In the eurozone and Japan, taxing banks that hold reserves (negative-interest-rate policy) will also encourage more bank lending, and thus stimulate growth.
In an era when public debt write-offs (haircuts) are widely viewed as unacceptable (witness the European Union’s position on Greece) and governments are often reluctant to write off private debts (witness Italy’s reluctance to impose a haircut on holders of banks’ subordinated debt), sustained negative ex post returns are the slow-burn path to reducing debt. Absent a surprise inflation spurt, this will be a long process.

The Fed's Loud Talk Policy

By: Peter Schiff

Theodore Roosevelt's famous mantra "speak softly and carry a big stick" suggested that the United States should seek to avoid creating controversies and expectations through loose or rash pronouncements, but be prepared to act decisively, with the most powerful weaponry, when the time came. More than a century later, the Federal Reserve has stood Teddy's maxim on its head. As far as Janet Yellen and her colleagues at the Fed are concerned, the Fed should speak as loudly, frequently, and as circularly as possible to conceal that they are holding no stick whatsoever.

Roosevelt's "stick" was America's military might, which in his day largely boiled down to the U.S. Navy, which he had enlarged and modernized. To demonstrate to a potential adversary that he was prepared to use these weapons, Roosevelt sent the fleet around the world in a massive show of force. However, he took care to couch the expedition in soothing rhetoric. He even ordered the battleships to be painted white to create the impression that they were angels of mercy rather than instruments of power. The combination proved effective. America's global influence increased dramatically during his presidency even though few shots were fired.

The "sticks" that Janet Yellen is supposedly ready to employ are interest rate increases that are needed to help normalize the economy, fight inflation, and to stockpile ammunition to combat the next recession. Yet, in the last decade interest rates have essentially been fixed at zero. In fact, since the end of 2008 the Fed has raised rates a grand total of once...last December, by just one quarter of a percent. But what they have lacked in action they have more than made up for with torrents of talk.

As a result of this "Loud Talk Policy," American economic prestige in the 21st Century has fallen faster than it rose in the Roosevelt presidency.

Ever since the Fed finally wound down its quantitative easing programs back in 2014, the big question became when it would "normalize" interest rates, bringing them back to the three to four per cent levels that had been in place for much of the past century. Over that time, the Fed has issued countless statements, both officially and unofficially, that discussed why, when, and how fast it will raise interest rates. Never before have so many words been spilled and parsed over a policy development that never had any chance of coming to fruition.

The simple truth, I believe, is that the Fed can't raise interest rates because its previous use of massive monetary stimulus to keep the country out of recession has created an economy that is hopelessly dependent on overly accommodating policy just to tread water. An economy is a physical thing. If it inflates too much, it must contract for balance and health to be restored.

The Fed has committed itself to prevent that.

When the dotcom bubble crashed in the late 1990's, the Fed and the Federal government inflated a much bigger bubble in housing to replace it. That produced some superficially good years, but the party couldn't last forever. When that larger bubble popped in 2008, the government promptly blew up an even larger bubble in bonds, stocks, and real estate simultaneously to replace it. After six years and many trillions of dollars of purchases of treasury and mortgage-backed bonds (through its bailout and quantitative easing programs), the Fed has brought long term bond yields down to almost nothing, which has helped juice corporate profits, encouraged consumer borrowing, and re-ignited another increase in home prices.

Since there has been historically low growth in productivity and business investment over the past eight years, these rising asset prices appear to be the only pillars that support our otherwise anemic economy. The Fed must know that any significant increases in interest rates could knock out these pillars, toppling the phony recovery, and perhaps bringing on another recession that it would be hard-pressed to stop. I believe the Fed is much more aware than the typical Wall Street economists that the economy, as currently constituted, would have a difficult time handling interest rates that are even within shouting distance of normal.

But the difficult part for them is that they can never really admit that they find themselves in this trap.

The Federal Reserve is now the country's primary economic cheerleader. Given how much weight the public ascribes to every utterance of the Fed, to admit that the economy is weak would be to create a self-fulfilling prophecy. So instead of keeping silent and acting decisively as TR would have done, the Fed talks in circles and does nothing. They talk over one another, sometimes saying the same thing, sometimes appearing to pull in opposite directions. Sometimes they just talk while saying nothing at all.

Yesterday's Fed statement is just the latest in a seemingly endless string of announcements that are meant to convey a sense of optimism and a feeling that some action is getting closer, even though nothing is actually likely to happen. When the statement was issued, Wall Street expressed little concern that the Fed had done nothing for the fifth consecutive meeting, but took immediate notice that the Fed had concluded that "risks to the economy had diminished."

To many, this meant that the next increase in rates could come as soon as the next meeting in September. Yet they have been saying versions of this for the past two years, and it resulted in one lone December rate hike, which was followed by the biggest January stock market rout in more than a century. (Ouch, Matt Phillips, Melvin Backman,1/20/16)

There are any number of economic or political developments that could occur in the next six weeks that could easily provide the Fed with yet another convenient excuse not to hike, without having to admit the real reason for its inaction. Last time it was Brexit. Before that, it was a weak jobs report.

Before that, it was market chaos in China. The bar keeps getting lower and they will always find something. Unfortunately, the media talking heads and the Wall Street mutual admiration society keep enabling them to continue the pantomime.

But the show can not go on forever. There is no way to know when a little dog might pull back the curtain and reveal the truth behind the illusion. Should that happen, the absence of a stick will prove to be a huge problem for the entire nation.

Not Much Is New in This Election

By George Friedman

The impression that this election cycle is unique is a common feature in American politics.

The United States now knows who the candidates of the two major political parties are. One of these two will most likely become president of the United States in January. As usual, each candidate and their partisans are predicting total catastrophe if the other wins. There are also claims that there has never been an election like this in history. As is normally the case, the candidate of the party out of power is claiming that the United States has reached a catastrophic point because of the current government. The other candidate is saying that the country is not collapsing but that it will collapse if the opposition’s candidate is elected.

This is pretty normal stuff, including the belief by much of the public that there has never been such an election before. But that is wrong. There have been others with much more at stake.

The 1861 election resulted in a civil war that killed 600,000 soldiers on both sides. In 1968, the leading candidate of the Democratic Party, Robert Kennedy, was murdered after winning the California primary. Martin Luther King Jr. had been murdered a few months before and the Democratic Convention was held amid massive riots outside the convention hall. In the end, Richard Nixon was elected, about which no more needs to be said. In the 2000 general election, there was a recount in Florida and the case wound up in the Supreme Court. The Democrats continue to claim the election was stolen.

On a minor note, John F. Kennedy was the first Catholic running for president and some people seriously believed that he would be controlled by the Pope. Some also believed Ronald Reagan was a hack actor without any knowledge of the world and unqualified to be president.

The same thing was said of Harry Truman when he ran in 1948, after serving as president for over three years. Chevy Chase portrayed Gerald Ford as too stupid to walk without falling over during the 1976 election. Barry Goldwater, in 1964, was accused by a bunch of psychiatrists who had never met him of being psychologically unstable. Lyndon B. Johnson was accused of being a criminal in 1964 because he became a multi-millionaire without ever holding a job outside government.

The point I am making is that the impression that there has never been an election like this one is common in every election cycle. And charges that one of the candidates is a criminal and the other is psychotic have been standard fare in American elections. My standard is whether electing either candidate will cause a civil war. Short of that, it is safe to conclude that the republic will survive either of them and the one elected, whoever it is, might surprise us.

The question is not why Americans regard this particular election as apocalyptic. The question is why Americans routinely regard presidential elections as apocalyptic, without realizing they are simply acting out an old script. One reason is a general one. Americans do not remember the past very clearly, particularly when it doesn’t directly affect their lives. America was founded without a past, but with a breathtaking future. As a culture, our focus has been there.

We get caught up in the moment and we lack a sense of perspective because our memory of the past has been rendered fuzzy, with the hard edges removed.

A second reason is that this is the only time, once every four years, that all Americans have the opportunity to participate in the same election. Otherwise, we vote for state office or congressional district or tax assessor. But every four years, there is an opportunity to release our pent-up anger. Americans were taught to be suspicious of monarchs at the founding, and the president is the closest we get to a monarchy. It is natural that we should distrust our president. Thomas Jefferson would have approved of it – except in his own case, of course.

We may not remember why, but we have a culture of distrusting the president. Even Franklin D. Roosevelt, revered now, was reviled by many for the New Deal and by those who felt he deliberately failed to defend Pearl Harbor. The president is the only lightning rod we have and it should not be surprising that our feelings are so intense before the election and drop off afterward, save for a few diehards getting ready for the apocalypse, which is also a feature of American culture.

The fact is that the president has very little power. Donald Trump wants to make the country great again. It’s a concept he borrowed from Reagan’s campaign against Jimmy Carter.

Nobody could oppose that. Americans constantly sense unprecedented catastrophe. In the 20th century, America was stunned by a virulent Great Depression, then stunned again by Pearl Harbor. Neither were expected and they reinforced the lesson taught in the Civil War that lurking beneath American peace and prosperity is a deep defect, a demon, that has seized us and is taking us to hell.

Hillary Clinton is running as a technocrat who can get the job done. She probably doesn’t remember that she is running on Herbert Hoover’s platform. Hoover, a brilliant engineer, wanted to bring technocratic government (though he didn’t call it that) to Washington to run it like he ran his engineering projects. Americans love the claim of competence but have learned from Hoover and his heir Jimmy Carter not to trust the people who believe in little but getting the job done right.

Trump comes across as the literary character Elmer Gantry, claiming to know the gate that leads to heaven, treating unpleasant questions as the work of the devil. Clinton comes across as a graduate student at the JFK School of Government at Harvard, spending her days studying and writing policy papers on obscure topics and at night doing the real work of schmoozing and maneuvering for some job or another.

Elmer Gantry and the grad school hustler are not exotic creatures. They are as American as apple pie. And there are many such stereotypes in American politics. A candidate for president must fit into this mold. Bernie Sanders was the aging hippie taking one more shot at trying to remember what he once believed. Jeb Bush was the man with the resume, the name and the money. He was the guy we all wished we were because he made it look easy – and for him it was.

In each campaign, we are presented with candidates who we have never met and whose real lives we know little or nothing about. The candidates are imbued with attributes that are about us, not them. Each are hated for reasons we fully understand and loved for the same reasons.

Then the election is over and he or she takes office and we remember that the president really doesn’t have the power to make us great again or to develop solutions to problems we might have.

The founders designed the presidency to preside over the process of government rather than to govern. Governing requires the other branches of the federal government and the states. We overestimate the power of the president enormously. The presidential candidates act as if they will rule. But the president only presides over the government and the elections every four years, in our personal experience, create a drama that always ends in the disappointment of inauguration. The one we hated is not a fiend. The one we loved is not a saint. And so we move on to more important things like earning a living and picking up the kids, and the urgency of the election fades for all but the few who remain obsessed.

The point is that there is a time for every season and this is the election season. Many believe the candidates have never been as vile or wonderful as this crew and the future of the republic depends on who is elected. That’s nonsense. There is no charge, no crime and no personality quirk we haven’t seen before. We just don’t remember. It's not that the election doesn't matter.

It's just that we've been here before.

IMF swayed by politics during eurozone crisis, say inspectors

WASHINGTON, DC - MAY 16: The International Monetary Fund Headquarters 2 building is seen thorugh Eduardo Chillida's 1969 sculpture "Around the Void V" May 16, 2011 in Washington, DC. A potential candidate for the French presidency and current IMF Managing Director Dominique Strauss-Kahn was detained May 14 on a departing airplane after he was accused of trying to rape a maid in a $3,000-a-night suite at a New York City hotel. (Photo by Chip Somodevilla/Getty Images)©Getty
The International Monetary Fund repeatedly succumbed to political pressure from European governments during the eurozone debt crisis, according a damning internal report on bailout strategy that will fuel debate over whether it should continue to fund Greece.
In-house inspectors highlighted a litany of flaws in the IMF’s “uneven” response, prompting calls for greater clarity over the fund’s rescue strategy for eurozone countries.

Their assessment raises fresh questions over the failure to restructure Greek debt at the time of its first bailout in 2010. The report, released on Thursday, said key decisions had already been reached in Europe by the time the fund became involved in the rescue effort.

Christine Lagarde, the IMF’s managing director since 2011, backed some of the inspectors’ recommendations for improving internal procedures but dismissed calls from the independent evaluation office (IEO) to fortify the fund’s defences against political interference.

“I support the principle that the IMF’s technical analysis should remain independent,” she said in a statement. “However, I do not accept the premise of the recommendation, which the IEO failed to establish in its report, and thus do not see the need to develop new procedures.”

The fund’s involvement in eurozone programmes had been a “qualified success” in the face of unprecedented systemic challenge, Ms Lagarde said.

Nonetheless, the report is likely to fan suspicions of some emerging market IMF shareholders and some of its staff that it repeatedly bent its own rules to help out the eurozone.

“It highlights the concerns of many — both inside and outside the fund – that the fund’s treatment of developing and emerging market economies is quite different from its treatment of advanced economies,” said Eswar Prasad, economics professor at Cornell University and former IMF official.

“Political factors seemed to play a bigger role than pure technical considerations in matters involving advanced economies.”

The inspectors said the troika arrangement — in which the IMF worked alongside the European Commission and European Central Bank — potentially subjected the technical judgment of IMF staff “to political pressure” from an early stage.

“The European Commission, in the area of emergency crisis lending, acted as the agent of the eurogroup, which in turn represented member states and decided whether to provide assistance.

“Interviews and some internal documents suggest that political feasibility in creditor countries was an important consideration for [European Commission] staff and that IMF staff occasionally felt pressured to accept a less-than-ideal outcome.

The inspectors said the IMF executive board, responsible for the fund’s day-to-day business, was in the dark on sensitive policy questions for Greece and Ireland, which also received a bailout in 2010.

Some executive board members, who usually meet several times each week, learned more from the press throughout the crisis period than from informal board meetings.

The board approved the first Greek deal in May 2010 “without seeking pre-emptive debt restructuring, even though its sovereign debt was not deemed sustainable with a high probability”.

“The risk of contagion was an important consideration in coming to this decision. The IMF’s policy on exceptional access to fund resources, which mandates early board involvement, was followed only in a perfunctory manner.”

The fiscal troubles of Greece remain unresolved, fanning concern about regional instability at a time of upheaval in Turkey. In recent days the US has pressed the country’s European creditors to allow a debt restructuring to restore order in its finances.

The inspectors, led by Japanese academic Shinji Takagi, found the IMF had considered the prospect of lending to a eurozone country to be unlikely and had never set out how such programmes might be designed.

The report said IMF managers had moved some time before the Greek rescue to explore contingencies. Still, the work of special task forces “was so secret that few within the institution knew of their existence, let alone the content of their deliberations”.

Ms Lagarde said IMF-backed programmes bought time to build firewalls, prevented the crisis from spreading, and restored growth and market access in Ireland, Portugal and Cyprus.

“Greece, however, was unique: while initial economic targets proved overly ambitious, the programme was beset by recurrent political crises, pushback from vested interests, and severe implementation problems that led to a much deeper-than-expected output contraction.

“On the other hand, Greece undertook enormous adjustment with unprecedented assistance from its international partners. This enabled Greece to remain a member of the euro area — a key goal for Greece and the euro area members.”