Can we plunge to a -4% or -5% interest rate?
We are heading a major economic and monetary problematic on this century. More than an economic problem, it remains a systemic problem. After the 2008/2009 crisis, central bankers lowered interest to 0%, and even to negative returns since 2015 in EU. Central banks are now using a considerable monetary creation in order to sustain budgets, debt, and economy. Furthermore, the next years could imply tensions on interest rate due to (1) the higher dependance to debt and (2) the lower solvability. The problem is quite simple: can we expect a -4% or -5% interest to maintain systemic stability?
We need to understand our own economy.
Lower rates are not always higher growth.
We all know the economic theory saying “make lower interest rate and you will get higher growth”. The fact is that history shows a different version. The graphic presented here shows the interest applied by the BoE since 1694. Crisis in the past (XIX) were solved through the assimilated Quantitative Tightening. The situation changed in the beginning of the XX century, especially after the 1907 panic. From the WWI to the end of WWII, central banks like FED or BoE – and others – used strong expansionists policies to sustain wars deficits (at the beginning of the 1940s, the BoE balance sheet was around 30% of the GDP). Then economy entered into a prosperous period (1946-1980s): higher growth, higher inflation, higher interest rate, lower global debt.
The end of monetary rigor in the 1970s (end of gold standard) and the 1980s (after the 1981 Volcker policy) – added to slowing demography, stronger globalization and new technologies – implied lower growth, lower inflation, lower rate, and higher indebtment. Since 2000s, at the exact mid-point the monetary cycle, central banks began to develop aggressively the lower rate policies. Since this period, real rate has been inferior to economic growth. Lower interest rate produced higher indebtment, lower inflation (deflationary pressure through “zombification” and taxation), and lower growth.
Historical plot repeats…until it repeats again.
We have to distinguish two dynamics:
1/ Central banks can only influence the amplitude of the economic and financial cycles but won’t never be able to change fundamental like demography, innovation in productivity or ideologies. The reality we are living in is crystal clear: declining demography in Europe or Japan, a phase transition of the 80y cycle of Schumpeter innovation in favor of technologies, social and political tensions, social austerity.
2/Long term V short term. Due to “immutable” economic fundamentals: apply a policy in favor of present and you will puncture future. Apply a policy in favor of future and you will puncture present. It is a simple equation through which we are now reducing solvability and rising tensions in the future only to avoid present. Central banks and States are just amplifying long term risks (lower potential growth, lower velocity and lower inflation) by reducing short term risks.
Fiscal and monetary expansionists policies are gradually playing against economic fundamentals, creating social tensions and bubbles in financial assets (real estate and equities destroying bond market) or boosting technologies (AI, cryptos, etc…). Don’t forget that the tensions of the Great Depression ended in the 1940s with higher interest rate. Not with lower rate. Manipulating interest rate is no more that playing with time and economic fundamentals. Lower rate is not always higher growth (or lower growth) and higher rate are not always lower growth (or higher growth). It just depends of your position in the monetary and the economic cycle.
What can we expect?
Inevitably, the next years will imply lower or higher rate. The fact is that none solution is the best and both are risked. If interest rate is maintained around 0%, we could expect higher rate on the very long-term plan due to the fundamental dynamic of stopping the indebtment bubble. There is also a cycle in debt. Simply because there is a structural link between interest paid and indebtment (graphic below).
As a result, lowering interest rate to -4% or -5% could imply: (1) higher indebtment that could (2) only be sustained by lower prices because the potential growth would be to much high compared to real rate. It is what I name the paradox of prices and growth. In a context of higher potential growth compared to real rate, if you lower rate you will systematically lowering potential growth what can only be avoided by deflation (or lower inflation). It is structural.
In other words, if we plunge to a -4% or -5% interest, it should only amplify the monetary and economic equilibrium we knew for 40 years. By doing so, solvability could collapse, what imply lower and lower interest rate… It is also what I describe as the collapse of the (marginal) efficiency of expansionist monetary and fiscal policies [my article]. A -4% or -5% is also taking the risk of going to a -80% or -90% rate in two or three decades in order to maintain an equilibrium only sustainable in an exponential monetary cycle.
In all cases, the 0% rate policy won’t be eternal. As always in a context of lower pressure on growth and higher pressure on interest rate, we must expect tensions (amplified by central banks year after year). We are respecting a monetary and economic cycle. The only thing we can do is playing with cycles in amplitude, not in time. The best solution could be to maintain a 0% rate for the next years; and then trying to sustain a phase transition in order to get higher rate in the future. Reducing the spread between real rate and growth is becoming a question of systemic stability; simply because the monetary cycle is reversing.
By Thomas Andrieu for ROCHEGRUP