Tony Ward is chief executive of Clayon Euro Risk
I wasn’t surprised to read that the Organisation for Economic Co-operation and Development (OECD) warned this week that permanently low interest rates are ruining investments and savings, the consequence of which is undermining long-term economic growth.
While very low rates are designed as an emergency boost for economies, they are harmful over long periods of time, the OECD’s study concluded. Its solution is for governments to reform stagnant economies, allowing bad companies to go bust, encouraging banks to write off loans to failing companies and encourage innovative firms to grow.
“Seven years of extremely easy monetary policy has restored the investment and productivity needed to raise income per head, real wages, demand and growth,” the OECD said. “This policy was originally designed to stabilise the financial system and support economic recovery, but somehow has slipped into trying to compensate for the absence of the other policies that are needed.”
Richer countries need to take weak companies and banks off life support and recognise that negative rates are harming even the healthy banks, the OECD warned. Those negative rates are also harming investors by creating ‘perverse incentives’ and driving irrational behaviour in markets. “Investors have been herded into concentrated trades, many of which are illiquid, and recent volatility reflects periodic attempts to exit them – particularly when there is any hint of a withdrawal of the monetary policy ‘morphine’ to which they have become addicted,” the report said. The OECD hopes that productivity will take off, which requires the ‘creative destruction’ of unproductive firms and the growth of innovative rivals – something that itself is stymied by low interest rates keeping weak firms alive.
Strong words; but, in my view, wise ones.
Others seem to agree. Deutsche Bank has warned that the European Central Bank’s loose monetary policy risks destroying the European project. Deutsche suggested the ECB had ‘lost the plot’ and its ‘desperate’ actions raised the risk of a potentially ‘catastrophic’ mistake by the central bank. David Folkerts-Landau, Deutsche’s chief economist, said negative interest rates and quantitative easing had hurt savers and allowed politicians to delay badly-needed structural reforms. “ECB policy is threatening the European project as a whole for the sake of short-term financial stability,” he concluded. “The benefits from ever-looser policy are diminishing while the litany of distortions, perversions and disincentives grows by the day…. Bad companies survive while good companies are too scared to invest.’
Mr Folkerts-Landau continued: “After seven years of ever-looser monetary policy there is increasing evidence that following the current dogma, broad-based quantitative easing and negative interest rates risk the long-term stability of the eurozone. Worse, by appointing itself the eurozone’s whatever-it-takes saviour of last resort, the ECB has allowed politicians to sit on their hands with regard to growth-enhancing reforms and necessary fiscal consolidation.”
What’s my view? It’s clear that monetary policy cannot work in isolation and a stronger inclusive policy is needed. I’ve mentioned this before but I see more and more that fiscal and monetary policies must work hand-in-hand and be promoted by politicians as well as finance ministers and central bankers.
The OECD does not expect any of these vital reforms to emerge soon, leaving the world economy trapped in an environment of low interest rates and low productivity growth. Unfortunately structural reform on the scale required is unlikely in the short-term. This means that creative destruction and a lift-off in rates is postponed. Central banks are most likely to continue with low interest rates and the quantitative easing approach.
Let’s hope for innovation sooner rather than later.