In a recent report, the European Systemic Risk Board (ESRB) warns about the consequences for financial stability of maintaining interest rates at low levels. This work, titled ‘Lower for Longer’, considers that the threats of the current rate scenario stem from various effects: the negative impact on bank profitability, the indebtedness and viability of borrowers, potential instability in financial markets, and the sustainability of business models of insurance companies and pension funds with medium- and long-term return commitments.
After a thorough reading of the report, an obvious question arises: considering so many risks, why not begin the return to monetary policy normalization now? Or, at least, why not establish a strategy to do so in the future? This is necessary, not only because of these and other risks to consider, such as the impact on investor expectations or the penalization of savers, but also because it is necessary to give greater prominence to fiscal policy and structural reforms to consolidate the recovery once the pandemic is overcome.
However, the response given so far by the European Central Bank (ECB) has been clear: “the Governing Council expects the ECB’s key interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics”. The latest inflation data for May has already exceeded 2.0%, but Christine Lagarde herself has been quick to consider it temporary and anticipate that it will not be reflected in inflation expectations. Monetary conditions will continue to be very favorable for economic recovery, despite the risk of excesses and financial imbalances that this may generate.
All analyses of the exceptional monetary measures of recent years focus on their positive past impact, but do not examine the balance of future benefits and costs. A recent ECB study, for example, valued asset purchases in the markets, negative interest rates and forward guidance very positively, in that order. The 2008 financial crisis that began in the United States, the Euro crisis in 2012 and the pandemic that we are overcoming with such effort and pain, have been reflected in increasingly exceptional monetary measures in response to a scenario that is also exceptional. Measures that, however, are not subsequently withdrawn once the exceptional situation is overcome. This has led us to consider normal a scenario where the main central banks are already a fundamental part in explaining the evolution of financial asset prices. And, especially, in anticipating their future behavior.
Behind the low interest rate scenario are structural factors such as demographics, low productivity, globalization, excess savings and scarce investment. It is likely that some of these factors are connected or may even feed back into each other in a low-return scenario. The high level of public debt and its impact on future uncertainty must also undoubtedly be considered, which may lead to a higher savings rate from a historical perspective and deteriorate productive investment despite such favorable financing conditions.
The ESRB report makes recommendations to mitigate some of the systemic risks mentioned, based on the fact that current macroprudential tools do not offer instruments that address the structural changes taking place in the financial system. Specifically, it advises not to lose sight of the growing market importance of the supply of financial services and products by new operators that are not subject to exhaustive banking regulation and supervision. It recommends linking risk to activity, regardless of who carries it out.
José Luis Martínez Campuzano, spokesperson for the Spanish Banking Association
