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The emerging consequences of record-low interest rates: bubbles, debt and potential crises

At the beginning of February this year, key economic indicators were released by the United States that suggested the global economy had turned a corner. For the first time since the Global Financial Crisis, the US Federal Reserve had lifted interest rates, unemployment was back down below 5% and ‘business as usual’ was re-entering the lexicon of global financial centres. However, one did not have to look far to find unease with this renewed positivity. Influential economic figures such as Raghuram Rajan, India’s Central Bank Governor, and Joseph Stiglitz, Nobel Prize winning economist, used the beginning of 2016 to highlight the growing concerns of record-low interest rates. At the heart of their concerns was the idea that the growing disparity between a surging financial assets sector and the general day-to-day economy, generated by record-low interest rates, was sending the ‘economic fundamentals’ of the global economy off the tracks. The recent Brexit vote has done little to help in this regard and has brought interest rates back into the forefront of global monetary policy.

During the Brexit debates in June, Janet Yellen used public appearances to highlight fears of the United Kingdom leaving the European Union as a crucial reason to halt a new US interest rate rise. This shroud of fear hanging over the Federal Reserve has also been noted by former Bank of England member Andrew Sentance, who has suggested that monetary policymakers are now in a phase of searching for fearful predictions to use as an excuse for holding off on making hard decisions. This has led some on Wall Street to predict that US interest rates are about to fall again, whilst European markets are now also forecasting a reduction in UK interest rates as a result of Brexit. The global economy is seemingly on the verge of fulfilling the concerns of Raghuram Rajan and Joseph Stiglitz.

The fundamental concerns around maintaining record-low interest rates moving forward is the potential supercharging effect on economic bubbles and surging personal debt. Eight years of cheap money has created a scenario where global stock markets continue to reach new record levels in mid-2016, yet job growth data coming out of the US at the same time shows a dramatic decline. Furthermore, analysis by Deutsche Bank has found that assets such as bonds, equity and real estate within 15 developed and major economies had reached 'peak valuation'. Their analysis has pointed the finger directly at record-low interest rates. However, when it comes to the largest potential problems caused by record-low interest rates, we are beginning to see a ‘one-two punch effect’ of low bank savings and surging personal debt on the global economy.

There are two factors in play when it comes to surging personal debt. At one level, lowering interest rates is a crucial policy lever to get the general public out into the shops and spending money. This has the effect of making personal savings unattractive to the average person. The problem with this is that interest rates have remained so low for so long that new data shows 20% of US citizens have zero bank savings and a further 28% could only rely on savings for one month. Meanwhile, at the second level, a reduction of savings then activates a vicious cycle which fuels personal debt. This cycle has begun in numerous western countries. In Australia household debt has reached 123% of GDP, in the US non-mortgage debt is continuing on an upward trend, and in the UK the Office for Budget Responsibility has called current UK household debt levels 'unprecedented'. This frightening outlook highlights the lacking robustness of the global economy to be able to respond to potential crises and thus raises the question: what can be done?

Moving forward there are three central steps that must be taken. Firstly, the US and UK central banks must halt any planned reduction in interest rates as a reaction to Brexit. There is no logically sound reason for further reductions in interest rates. A reduction in rates will only signal that central bankers have completely lost their ability to undertake sound monetary policy decisions, and will also confirm the fears of people like Andrew Sentance. Secondly, by December of this year the US must increase interest rates by 0.15-0.25% to signal to the markets that the era of cheap money is over and that the Federal Reserve is functioning once more with a plan to sustain rate rises. Thirdly, both Hillary Clinton and Donald Trump must use the upcoming US elections to place the Federal Reserve at the heart of the economic debate and give central bankers confidence to act.

Charles Bryant is the International Trade and Economy Fellow for Young Australians in International Affairs.

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Image credit: Brett Leckman (Flickr: Creative Commons)

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