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Kenneth Rogoff: Low rates worldwide cannot last

The global savings glut will end and central banks will learn they must tolerate high inflation

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How long can today’s record-low, major-currency interest rates persist? Ten-year interest rates in the United States, the United Kingdom and Germany have all been hovering around the once-unthinkable 1.5 per cent mark. In Japan, the 10-year rate has drifted to below 0.8 per cent. Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation. Indeed, the rate on inflation-adjusted Treasury bills (so-called “TIPS”) is now negative up to 15 years.

Is this extraordinary situation stable? In the very near term, certainly; indeed, interest rates could still fall further. Over the longer term, however, this situation is definitely not stable.

Three major factors underlie today’s low yields. First and foremost, there is the “global savings glut”, an idea popularised by current Federal Reserve Chairman in a 2005 speech. For various reasons, savers have become ascendant across many regions. In Germany and Japan, ageing populations need to save for retirement. In China, the government holds safe bonds as a hedge against a future banking crisis and, of course, as a byproduct of efforts to stabilise the exchange rate.

Similar motives dictate reserve accumulation in other emerging markets. Finally, oil exporters such as Saudi Arabia and the seek to set aside wealth during the boom years.

Second, in their efforts to combat the financial crisis, the major have all brought down very short-term policy interest rates to close to zero, with no clear exit in sight. In normal times, any effort by a central bank to take short-term interest rates too low for too long will boomerang. Short-term market interest rates will fall, but, as investors begin to recognise the ultimate inflationary consequences of very loose monetary policy, longer-term interest rates will rise.

This has not yet happened, as central banks have been careful to repeat their mantra of low long-term inflation. That has been sufficient to convince markets that any stimulus will be withdrawn before significant inflationary forces gather.

But a third factor has become manifest recently. Investors are increasingly wary of a global financial meltdown, most likely emanating from Europe, but with the US fiscal cliff, political instability in West Asia, and a slowdown in China all coming into play. Meltdown fears, even if remote, directly raise the premium that savers are willing to pay for bonds that they perceive as the most reliable, much as the premium for gold rises. These same fears are also restraining business investment, which has remained muted, despite extremely low interest rates for many companies.

It is the combination of all three of these factors that has created a “perfect storm” for super low interest rates. But how long can the storm last? Although highly unpredictable, it is easy to imagine how the process could be reversed.

For starters, the same forces that led to an upward shift in the global savings curve will soon enough begin operating in the other direction. Japan, for example, is starting to experience a huge retirement bulge, implying a sharp reduction in savings as the elderly start to draw down lifetime reserves. Japan’s past predilection towards saving has long implied a large trade and current account surplus, but now these surpluses are starting to swing the other way.

Germany will soon be in the same situation. Meanwhile, new energy extraction technologies, combined with a softer trajectory for global growth, are having a marked impact on commodity prices, cutting deeply into the surpluses of commodity exporters from Argentina to Saudi Arabia.

Second, many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices.

It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation — an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation.

Third, eventually the clouds over Europe will be resolved, though I admit that this does not seem likely to happen anytime soon. Indeed, things will likely get worse before they get better, and it is not at all difficult to imagine a profound restructuring of the euro zone. Nevertheless, whichever direction the euro crisis takes, its ultimate resolution will end the extreme existential uncertainty that clouds the outlook today.

Ultra-low interest rates may persist for some time. Certainly Japan’s rates have remained stable at an extraordinarily low level for a considerable period, at times falling further even as it seemed that they could only rise. But today’s low interest rate dynamic is not an entirely stable one. It could unwind remarkably quickly.


The writer is a professor of economics at Harvard and a former chief economist at the IMF.
Copyright: Project Syndicate, 2012

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Kenneth Rogoff: Low rates worldwide cannot last

The global savings glut will end and central banks will learn they must tolerate high inflation

How long can today’s record-low, major-currency interest rates persist? Ten-year interest rates in the United States, the United Kingdom and Germany have all been hovering around the once-unthinkable 1.5 per cent mark. In Japan, the 10-year rate has drifted to below 0.8 per cent. Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation.

How long can today’s record-low, major-currency interest rates persist? Ten-year interest rates in the United States, the United Kingdom and Germany have all been hovering around the once-unthinkable 1.5 per cent mark. In Japan, the 10-year rate has drifted to below 0.8 per cent. Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation. Indeed, the rate on inflation-adjusted Treasury bills (so-called “TIPS”) is now negative up to 15 years.

Is this extraordinary situation stable? In the very near term, certainly; indeed, interest rates could still fall further. Over the longer term, however, this situation is definitely not stable.

Three major factors underlie today’s low yields. First and foremost, there is the “global savings glut”, an idea popularised by current Federal Reserve Chairman in a 2005 speech. For various reasons, savers have become ascendant across many regions. In Germany and Japan, ageing populations need to save for retirement. In China, the government holds safe bonds as a hedge against a future banking crisis and, of course, as a byproduct of efforts to stabilise the exchange rate.

Similar motives dictate reserve accumulation in other emerging markets. Finally, oil exporters such as Saudi Arabia and the seek to set aside wealth during the boom years.

Second, in their efforts to combat the financial crisis, the major have all brought down very short-term policy interest rates to close to zero, with no clear exit in sight. In normal times, any effort by a central bank to take short-term interest rates too low for too long will boomerang. Short-term market interest rates will fall, but, as investors begin to recognise the ultimate inflationary consequences of very loose monetary policy, longer-term interest rates will rise.

This has not yet happened, as central banks have been careful to repeat their mantra of low long-term inflation. That has been sufficient to convince markets that any stimulus will be withdrawn before significant inflationary forces gather.

But a third factor has become manifest recently. Investors are increasingly wary of a global financial meltdown, most likely emanating from Europe, but with the US fiscal cliff, political instability in West Asia, and a slowdown in China all coming into play. Meltdown fears, even if remote, directly raise the premium that savers are willing to pay for bonds that they perceive as the most reliable, much as the premium for gold rises. These same fears are also restraining business investment, which has remained muted, despite extremely low interest rates for many companies.

It is the combination of all three of these factors that has created a “perfect storm” for super low interest rates. But how long can the storm last? Although highly unpredictable, it is easy to imagine how the process could be reversed.

For starters, the same forces that led to an upward shift in the global savings curve will soon enough begin operating in the other direction. Japan, for example, is starting to experience a huge retirement bulge, implying a sharp reduction in savings as the elderly start to draw down lifetime reserves. Japan’s past predilection towards saving has long implied a large trade and current account surplus, but now these surpluses are starting to swing the other way.

Germany will soon be in the same situation. Meanwhile, new energy extraction technologies, combined with a softer trajectory for global growth, are having a marked impact on commodity prices, cutting deeply into the surpluses of commodity exporters from Argentina to Saudi Arabia.

Second, many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices.

It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation — an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation.

Third, eventually the clouds over Europe will be resolved, though I admit that this does not seem likely to happen anytime soon. Indeed, things will likely get worse before they get better, and it is not at all difficult to imagine a profound restructuring of the euro zone. Nevertheless, whichever direction the euro crisis takes, its ultimate resolution will end the extreme existential uncertainty that clouds the outlook today.

Ultra-low interest rates may persist for some time. Certainly Japan’s rates have remained stable at an extraordinarily low level for a considerable period, at times falling further even as it seemed that they could only rise. But today’s low interest rate dynamic is not an entirely stable one. It could unwind remarkably quickly.


The writer is a professor of economics at Harvard and a former chief economist at the IMF.
Copyright: Project Syndicate, 2012

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