Low Interest Rates:
King Midas’ Golden Touch?
Kristin Forbes
External MPC Member
Bank of England
Institute of Economic Affairs, London
24 February 2015
King Midas’ Golden Touch
The Costs
The UK Economy Today
• UK recovery well in progress and self-sustaining
– Still substantial challenges & scars from recession
– But economy largely normalizing after severe & protracted crisis
• One exception: interest rates
– Near-zero rates key part of crisis response & early stages of
recovery
– Near-zero rates provide a number of benefits
• But there are also costs and risks
Potential Costs of Low Rates
(1) inflationary pressures;
(2) asset bubbles and financial vulnerabilities;
(3) limited tools to respond to future challenges;
(4) an inefficient allocation of resources / lower productivity;
(5) vulnerabilities in the structure of demand; and
(6) higher inequality
Key question today: Does the policy of near-zero interest
rates risk going the way of Midas’ golden touch?
Risk 1: Inflationary Pressures
Recent and Forecast CPI Inflation
Source: BOE, February Inflation Report
Domestically-Generated Inflation (DGI) Measures
Range of DGI measures
YoY inflation %
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
1998
2001
2004
2007
2010
2013
Source: ONS and Bank calculations.
DGI measures
recently stable
Inflation: Looking Forward
•
Low headline inflation and stable DGI unlikely to persist
• Output gap closing
• Wage inflation picking up
• But pressures should build slowly
• Risks that inflation could pick up faster
• See Jan. speech, “Risks Around the Forecast
• Also risks that inflation picks up more slowly
• Bottom line: current policy does not yet appear to be
generating incipient inflationary pressures that could not
be addressed in a timely fashion as needed
Risk 2: Asset Bubbles &
Financial Instability
Risks to Financial Stability
•
Various risks:
• “Search for yield”
• Bubbles
• Increased risk by banks
• Increased debt issuance by companies
• Long academic literature on risks (see speech text)
• Financial Policy Committee (FPC): 1st line of defence
• Will the tools of the FPC be enough in the future?
• Risks magnified over time & by lower rates in other
economies
•
• May be role for monetary policy to “get in the cracks” in the
future, albeit not today
Risk 3: Limited Monetary Policy
Tools in the Future
UK: Frequent Use of Bank Rate
UK business cycle slowdowns and Bank Rate:
Source: OECD and Bank of England.
UK: Bank Rate Adjustments During Slowdowns
Business cycle
Dates of
Months of
Fall in Bank rate over
slowdowns:
easing cycle:
easing:
easing cycle:
Jan 1980 - April 1981
Jul 1980 - Mar 1981
9
5.00pp
Jan 1984 - Nov 1985
Mar 1985 - May 1986
15
4.00pp
Nov 1988 - May 1992
Oct 1990 - Feb 1994
41
9.75pp
Nov 1994 - Sep 1996
Dec 1995 - Jun 1996
7
1.00pp
Jan 1998 - April 1999
Oct 1998 - Jun 1999
9
2.50pp
May 2000 - May 2002
Feb 2001 - Jul 2003
30
2.50pp
Jan 2004 - Nov 2004
None
0
0.00pp
Dec 2007 - Jun 2009
Dec 2007 - Mar 2009
16
5.25pp
16
3.75pp
Average:
Source: OECD and Bank of England.
Risk 4: Inefficient Allocation of
Resources / Lower Productivity
Zombies
Liquidations, Interest Payments & Profitability
Company liquidations and
loss-making companies
Company liquidations and
interest payments
Per cent
Interest payments
compared to pre-tax
profits (RHS)
35
Per cent
0.8
0.7
30
Liquidations as a
percentage of active
companies (LHS)
25
0.6
Thousands
15
33
25
10
15
0.3
10
0
2002
2006
2010
29
27
0.4
0.1
1998
31
20
2014
Source: ONS, Department of Business, Innovation
and Skills and Bank calculations.
25
23
0.2
1994
35
0.5
20
5
1990
Per cent
30
5
21
Loss-making firms (rhs)
19
Company liquidations (lhs)
17
0
15
1990 1993 1996 1999 2002 2005 2008 2011
Source: Bureau van Dijk, Department of Business,
Innovation and Skills and Bank calculations.
Risk 5: Increased Vulnerabilities in
the Structure of Demand
Consumption Growth and Savings Rates
Consumption annual growth
Savings ratio
Per cent
14
12
10
8
6
4
2
Source: ONS and Bank calculations.
2014Q1
2012Q1
2010Q1
2008Q1
2006Q1
2004Q1
2002Q1
2000Q1
1998Q1
2014Q1
2012Q1
2010Q1
0
2008Q1
2006Q1
2004Q1
2002Q1
2000Q1
1998Q1
Percentage change on
a year earlier
8
6
4
2
0
-2
-4
-6
Household Balance Sheets
Household debt to income and
deposits to income ratios
Distribution of mortgage debt
to income ratios
Per cent
150
140
130
Debt to income(b)
120
110
100
90
80
70
Deposits to income(c)
60
50
1987
1992
1997
2002
2007
Source: ONS and Bank calculations.
2012
UK Current Account and Trade Balance
£ billion
Current account balance
Goods and services
5
0
-5
-10
-15
-20
-25
-30
1998
2000
2002
Source: ONS and Bank calculations.
2004
2006
2008
2010
2012
2014
Risk 6: Inequality
Inequality
Distribution of household
financial assets by age group
Distribution of household
financial assets
Key Distributional Effects of Lower Rates
•
Boost asset values (equities)
•
Reduce pension annuities, interest on savings & other
fixed income payments
•
Reduce mortgage, interest and other payments on
borrowing
•
Stimulate job creation
•
Overall: Net effects on inequality unclear
Conclusions
Tying it All Together
(1) inflationary pressures
(2) asset bubbles and financial
vulnerabilities
(3) vulnerabilities in the structure of
demand
(4) an inefficient allocation of resources
and lower productivity
(5) higher inequality
(6) limited tools to respond to future
challenges
Watch
closely,
could soon
factor into
decision
Mixed
evidence,
further from
MPC
mandate
Final Thoughts
King Midas washing away his touch
in the River Pactolus