 Financial Group
German Savings and Giro Association (DSGV)
Statement
Low interest rates jeopardise affluence and stability
By the Chief Economists of the German Savings Banks
Financial Group
5th November 2012
Chief Economist Uwe Dürkop - LBB
Chief Economist Folker Hellmeyer - Bremer LB
Chief Economist Dr. Ulrich Kater - DekaBank
Chief Economist Dr. Peter Merk - LBBW
Chief Economist Dr. Cyrus de la Rubia - HSH Nordbank
Chief Economist Dr. Jürgen Pfister - BayernLB
Chief Economist Dr. Patrick Steinpaß - DSGV
Chief Economist Dr. Gertrud Traud - Helaba
Chief Economist Torsten Windels - NordLB
Co-ordination: Dr. Reinhold Rickes - DSGV
 Financial Group
German Savings and Giro Association (DSGV)
The DSGV's Chief Economists take a critical view of the current low-interest-rate phase: the
top priority must continue to be cementing confidence in a stable currency and thus averting
threats to affluence and stability:
A multi-year phase marked by very low interest rates poses risks:

Asset erosion: Negative real interest rates eat into the value of monetary assets.

Old-age provision: A low interest-rate level undermines the propensity to save. With
interest rates at their current levels, however, the existing pension gaps can only be
bridged with the help of higher savings volumes.

Distortions in allocation, and the risk of a new bubble emerging: Low interest rates can
trigger evasive reactions, which - in turn - will give rise to price distortions on the markets
affected.

Readiness to take risks: In the long term, low interest rates will endanger the financial
stability which has been strengthened, in the short term, by interest-rate cuts.

Inflation: Low interest rates can engender higher inflation.
The following triad of measures are therefore required to eliminate the root causes:

Reduction of debt ratios in order to restore confidence in the financial system: Debt
consolidation remains a matter of priority.

Single-minded implementation of the concrete solutions which have already been come
up with in order to restore confidence in the European Monetary Union: In this context, the
new mechanisms enabling economic-policy and fiscal-policy co-ordination need to put
into practice in a credible and sustained manner.

Improving growth conditions in order to restore confidence in the European economy:
Boosting growth potential and competitiveness are decisive pillars underpinning such an
architecture.
Statement
Berlin, 5 November 2012
page 2
Low interest rates jeopardise affluence and stability
1. Point of departure and background
An unusually low interest-rate level has prevailed for quite some time now not only in Germany
but also in other advanced economies. To a large extent, this has been brought about by the
monetary-policy stance being adopted by central banks. In the USA, the Fed has kept the fed
funds target range in a range of 0% to 0.25% since December 2008 - the lowest level since the
Federal Reserve was set up in 1913; the Bank of Japan has already been pursuing a zero-interestrate policy since 2000, while the Bank of England froze its key rate at a historical low of 0.5% back
in 2009. The European Central Bank, meanwhile, cut its main interest rate to 0.75% in July of this
year, having already loosened the monetary reins last November. Almost all central banks are
more or less clearly signalling that they regard the current interest-rate level as appropriate for a
relatively long time to come - even though the ECB definitely emphasises again and again that it
is not prepared to give clues about the future path of interest rates ("We never precommit“).
In the Federal Republic, as in a number of other member states of the European Monetary Union,
such monetary-policy influence on interest rates is being further amplified by capital movements
sparked by the sovereign-debt crisis: the flight to safe investment vehicles such as government
bonds and the banking system in Germany has caused the entire interest-rate spectrum across all
market segments to ratchet down to an unprecedentedly low level, at which it still remains.
Deposit interest rates, mortgage interest rates, credit interest rates, and bond yields are
unusually low. In the case of safe-haven investments, interest-rate levels are so low in some cases
that they do not offer compensation for inflation even now, at a time when prevailing inflation
rates are moderate: Germany is witnessing negative real interest rates. Never before has the
German financial system been exposed to such a pronounced and prevalent low-interest-rate
environment.
The counter-example repeatedly adduced in this connection - the high interest rates which are
being charged for overdraft facilities - does nothing to alter this picture. For one thing, overdrafts
account for just 1.9% of aggregate loans granted to private households, the reason being that
they serve only to bridge short-term financing gaps rather than as long-term consumer loans. For
another thing, the distinctly higher interest rates charged for this type of loan are justified similar to the situation on the corporate-bond market, where higher-yielding instruments can
also be found - as a result of the considerably higher risks involved for the banking institution
making such loans. State intervention at this point in the interest-rate-setting process would
deactivate market mechanisms and would, in many cases, lead to the loan offer in question being
discontinued.
Statement
Berlin, 5 November 2012
page 3
From a macroeconomic viewpoint, the current interest-rate policy being pursued is warranted as
a response to the financial crisis which began brewing in 2007. The fact that, from this point in
time onwards, the debt ratios of various sectors in individual countries (private households,
states or banks) were no longer regarded by financial markets as being sustainable added up to
an overall picture which - in spite of energetic countermeasures on the part of economic policymakers - led to a massive loss of confidence in the financial system, but also in the real economy.
In the euro zone, this erosion in confidence precipitated a deeper debt crisis in a number of
member states which - in the eyes of a number of observers - actually threatened the very survival
of the EMU currency union. Taken together, all these factors are putting a severe strain on
confidence in the future viability of the economy and therefore on its growth prospects. A low
interest-rate level, engineered by monetary policy-makers, is admittedly the temporarily right
answer in such a situation. On its own, however, this cannot resolve the problems bound up with
excessive debt levels. The debt problem must continue to be tackled by the participants involved.
Looked at in the round, the current constellation is also characterised by a scenario in which
wealth which has come into being thanks to bloated asset prices rather than being built up in a
lasting fashion is being destroyed once again, for example in Spain's real-estate sector. A
contributory cause here are low interest rates, which are the result of an expansionary monetary
policy in conjunction with a fiscal policy committed to consolidation but also geared to
strengthening the factors affecting growth. In addition, inflation is eroding the real value of
monetary assets. This interplay between monetary policy and fiscal policy, entailing low interest
rates and inflation rates significantly in excess of interest rates, is distributing losses and is
therefore preventing the world economy from collapsing. In this sense, the currently low interestrate level is appropriate and is progressively promoting consolidation.
2. The enduring consequences of low interest rates
Extremely low interest rates involve substantial collateral damage if they are allowed to persist
for years on end:

Asset erosion: Negative real interest rates gnaw away at the value of existing monetary assets.
In the Federal Republic, more than half of the monetary assets held by private households are
accounted for by bank deposits and government bonds, which are currently offering the
lowest yield and are thus most keenly exposed to losses in terms of real value. Even in the
event of inflation rates of 3% in Germany, annual real losses incurred by private households
could amount to more than EUR 50 billion (the interest rate would surely react to this!).

Old-age provision: A low interest-rate level is a disincentive for the propensity to save. It will,
it is true, stimulate consumer demand; but with interest rates at the current level, existing
pension gaps could only be bridged with the help of higher savings volumes. Against the
Statement
Berlin, 5 November 2012
page 4
backdrop of the demographic development in the Federal Republic, wealth accumulation for
the purposes of old-age provision is indispensable. A low-interest-rate phase lasting many
years results in far lower future levels of protection, with implications for the claiming of state
benefits. It should be noted that this does not merely affect large fortunes but is particularly
perceptible in the case of small and medium-sized fortunes, the accumulation of which needs
to be promoted in a carefully-targeted way due to the burdens facing the state pension
system.

Distortions in allocation, and the risk of a new bubble emerging: Low interest rates can cause
investors to take evasive action, provoking price distortions on the markets affected. By way
of illustration, real-estate prices in certain regions of Germany have already risen noticeably
over the past two years. Although this can still be explained in terms of a catch-up
development in the wake of a long period of stagnating prices, there is nonetheless a growing
risk of price overshoots. Warning signals would be sounded here if such an upward movement
were to be accelerated by a higher level of borrowing or indeed by speculatively-motivated
purchases. Admittedly, this is not yet the case in Germany, but it would be a probable scenario
further down the line if the phase which we have already been in for some time now were to
become enduringly entrenched. Moreover, switching operations designed to escape the
current interest-rate environment in search of higher interest rates could, even now, prove to
be a more serious development, for example because of the sharp price losses on bond
markets which they would inevitably involve.

Readiness to take risks: In the long term, low interest rates will endanger the financial stability
which has been strengthened, in the short term, by interest-rate cuts. Not only private
households but also financial institutions are tending to resort to more risky asset classes in
order to make up for the poor investment yields they are generating elsewhere. It is therefore
important that such investment activity should be underwritten by investments in the real
economy which help economies to progress. For instance, Germany's turnaround in energy
policy ("Energiewende") is offering scope for sustainable investment; by contrast, promotion
of investments lacking an underpinning in the real economy and entailing higher risks should
be avoided (where is this taking place?). It cannot therefore be ruled out, in phases marked by
low interest rates, that loans will be extended to borrowers with poorer credit profiles, or
indeed to bad debtors, and that unprofitable economic structures will therefore continue to
be supported by the banking system.

Inflation: Low interest rates can feed through into higher inflation. According to conventional
thinking, however, this is only going to prove to be the case when an expansionary monetary
policy coincides with an economy working at full capacity. This is not going to be the case, on
average, in the euro zone in the foreseeable future. On the other hand, some parts of the euro
area are relatively close to this particular brink. This applies to Germany too (albeit to a
Statement
Berlin, 5 November 2012
page 5
decreasing extent!). At any rate, the negative real interest rates prevailing at the moment add
up to an excessively expansionary monetary environment for the German economy. As a
consequence, inflation rates in the Federal Republic could climb in the coming years to above
the "close to 2%" level which the ECB regards as being compatible with medium-term price
stability. It is also conceivable that oil prices could move up significantly within the framework
of fresh asset-price bubbles (many investors see commodities as an asset class), with upside
pressure on consumer-price inflation being generated in this manner.
By comparison to the situation in other euro-zone member countries, the negative effects of a
lengthy low-interest-rate phase are particularly conspicuous in Germany. Even now, the nominal
interest rate in the Federal Republic is lower than in other member states. At the same time, the
inflation rate in Germany could exceed those in the crisis-ridden states of Southern Europe in the
years to come. This is desirable and necessary if Europe's southern periphery is to regain its
competitiveness. Such an adjustment process will probably be speeded up if inflation rates
decline again in the crisis-ridden member countries (after the inflationary effects of value-addedtax increases have dropped out of the picture) and prove higher in Germany on account of
superior competitiveness and of a persistently better economic trend. It is true that negative real
interest rates make it easier for the public sector in the Federal Republic to tackle the task of
consolidation and therefore also promote the debt-reduction process. At the same time, however,
they constitute a kind of "creeping redistribution", with wealth being taken away from those with
smaller and medium-sized fortunes, in particular, and handed over to the debtors.
It is important to recognise that extremely low interest rates are merely symptoms of deeperlying problems afflicting economies. The principal problems in this category at the moment are
the high debt ratios of states, but also of other sectors of European - especially Southern
European - economies. Such debt burdens are continuing to weigh on economic actors'
confidence in the future of. Without such confidence in future growth, no investment activity is
going to take place today. In this context, low interest rates do not constitute a solution to the
existing debt problem; they merely facilitate debt sustainability for a certain length of time. The
longer they are allowed to persist, the more new problems they create.
3. Putting an end to the current phase of low interest rates remains a matter of priority
For these reasons, central banks would be right to seek to put an end to the current phase of low
interest rates when confidence has returned on financial markets. From the monetary-policy
vantage-point, the conventional and unconventional measures being adopted are an appropriate
policy enabling a minimum of financial stability and real economic activity to be maintained at a
time when huge asset-price bubbles are correcting. In view of this, the decisive precondition for
putting an end to such an extreme interest-rate configuration is to eliminate its causes:
Statement
Berlin, 5 November 2012
page 6
-
Reducing debt ratios in order to restore confidence in the financial system: This also involves
detecting and writing down claims in danger of becoming non-performing within the
European banking system (without risking a banking collapse in the process). The losses
materialising as a result need to be apportioned, as far as possible, to those who caused
them, and it would be wrong to shy away from bailing in private creditors in this context. In
those cases where financial institutions are no longer viable, they would need to be wound up
with due regard for systemic stability. At the state level, the solution to this problem would
include single-minded consolidation but also, at the same time, using all available means to
strengthen growth, through structural reforms in particular. At the beginning of such a
process, there would be negative repercussions on economic activity, but these would wane
over the course of a multi-year consolidation programme, provided that the latter were largely
implemented via the expenditure side of the government budget.
-
Single-minded implementation of concrete solutions - consisting, on the one hand, of
national adjustments via consolidation and, on the other, of structural reforms designed to
strengthen growth - in order to restore confidence in the European Monetary Union. The
conditional credit facilities made available by the EFSF/ ESM as well as by the ECB ensure that
member countries will receive the interim financing required for a multi-year adjustment
process. On top of this, future disequilibria are to be avoided through closer co-ordination of
economic policy and fiscal policy along with the constitutional requirement to balance the
budget in the medium term. This path needs to be followed single-mindedly.
-
Improving growth conditions in order to restore confidence in European economies: apart
from repair work in financial sectors, the pre-eminent task facing European economic policymakers is to move the economy back on to a higher growth path even under changed
demographic circumstances. Further reforms of labour, goods and services markets and of
social-security and education systems are items on the agenda here. Germany is not exempt
on this score.
4. It takes time for confidence to return
In the light of the adjustment speeds in the case of such macroeconomic disequilibria, it will take
some years - even on a best-case scenario - until such confidence has been regained. At that
point, it will be time to plan an exit from the policy of extremely low interest rates and overly
ample liquidity provision in such a way that growth and price stability continue to be
safeguarded.
If they are to maintain a minimum level of confidence in the financial system, central banks
currently have no alternative to continuing with their low-interest-rate policy coupled with
extremely weak money-supply growth. However, such a policy is not a "cure-all". Previous
Statement
Berlin, 5 November 2012
page 7
experience with unconventional monetary-policy measures in times of crisis shows that the effect
of the instruments involved can fade over time. Were this to happen, there would be a threat of a
further loss of confidence, with corresponding negative ramifications for growth and affluence.
Political decision-makers are therefore called upon not to be satisfied with having managed to
place the patient in "recovery position" but need instead to work energetically to cure the
remaining ailments that are afflicting him.
 Financial Group
German Savings and Giro Association (DSGV)
Summary
Memorandum and previous Statements by the Chief Economists of the German Savings Banks
Financial Group
18 October 2012
Statement: "ECB bond purchases remain a problematic
makeshift arrangement."
10 September 2012
Statement: "Stable fiscal policy for Europe."
28 August 2012
Statement: "Financial transactions tax: A critical appraisal."
25 June 2012
Statement: "After the election: Tackling the problems
outside Greece."
21 May 2012
Statement: "European Monetary Union: Sticking to the
reform tack - while widening flexibility."
23 April 2012
Statement: “The European Stability Mechanism is replacing
the EFSF bail-out scheme but is not, on its own, a solution.“
19 March 2012
Statement: “After the haircut: No respite in the sovereigndebt crisis."
24 February 2012
Statement: “Greece: Not fleeing but standing one’s ground.“
13 January 2012
Statement: “Monetary policy needs to remain credible."
29 November 2011
Statement: “Sovereign-debt crisis: time to take action!“
3 November 2011
Statement: “After the euro summit: extensive measures to
stabilise the financial markets.“
25 October 2011
Statement: “The haircut and the EFSF – giving them an
efficient form.“
24 September 2011
Memorandum on current issues “Europe and the euro.“
Published on 24.9.2011, Washington D.C., on the occasion of
the 2011 IMF/World Bank annual meeting.