Speech by Dimitris Malliaropulos, Chief Economist, Director of the Economic Analysis and Research Department of the Bank of Greece, on “Monetary policy in a low interest rate world”
01/11/2018 - Press Releases
At a conference organised jointly by the Bank of Albania and the London School of Economics and Political Science, in Tirana, on Thursday, 1st November, Dimitris Malliaropulos, Chief Economist, Director of the Economic Analysis and Research Department of the Bank of Greece, delivered an invited speech entitled “Monetary policy in a low interest rate world”. Mr. Malliaropulos presented the results of a study of the Bank of Greece, indicating that:
a. low interest rates are likely to last;
b. central banks are likely to continue to use quantitative easing (QE) in the future, as the zero lower bound (ZLB) will remain binding in the mid-term; and
c. central banks should consider the benefits from keeping their balance sheets large.
In particular, data from the balance sheets of the Federal Reserve Bank of the United States, the European Central Bank, the Bank of England and the Bank of Japan show that central banks have quadrupled their assets since 2007, as a result of the quantitative easing policies implemented in response to the global financial crisis. According to research conducted in the Bank of Greece, this rise in central bank assets has led to a permanent decline in sovereign bond yields globally, by 250 to 330 basis points, depending on their credit ratings.
Also, looking forward, bond market expectations point to a decline in short-term rates. Specifically, the 10-year US Treasury bond yields incorporate an expected fed funds rate of 3% over the next decade.
A possible explanation for the low level of interest rates is the decline in the “natural” interest rate stemming from the deceleration of the long-term growth rate (Holston, Laubach and Williams, 2017). As a consequence, the ZLB becomes even more binding, as central banks have less room to cut interest rates in the event of a recession.
On the other hand, academic studies show that hysteresis in potential output, which is related to the “natural” interest rate, may be due to one or more of the following factors: a chronic weakness of demand (see Summers, 2014); a slow deleveraging process of the private and public sector (see Reinhart and Rogoff, 2009); a debt “supercycle” (see Rogoff, 2015 - Lo and Rogoff, 2015); or to a decline in the global supply of safe assets (see Caballero and Fahri, 2014). In this regard, the decline in interest rates has come as a result of temporary (but relatively persistent) headwinds, arising from the global financial crisis of 2007-8.
All in all, there is no strong case for a fundamental change in the monetary policy framework. Central banks are expected to continue to use the asset side of their balance sheets, as well as other tools such as forward guidance, in addition to their standard interest rate policies, as the ZLB will continue to be a binding constraint on interest rate policy in a low inflation, low interest rate environment. Finally, central banks are likely to proceed to the downsizing of their balance sheets in gradual and cautious steps. In any case, also taking into account the hazards, sustaining the present high levels of central bank assets creates benefits for the economies and financial markets alike. These benefits relate to the maintenance of high liquidity conditions for banks and the economy, the supply of safe short-term assets and the avoidance of financial turbulence in the event of a sudden rise in interest rates.
References:
• Caballero, R.J. and Fahri, E. (2014), “The safety trap”. NBER Working Paper No. 19927.
• Holston, K., Laubach, T. and Williams, J.C. (2017), “Measuring the natural rate of interest: International trends and determinants”, Journal of International Economics 108, pp. S59-S75.
• Lo, S. and Rogoff, K. (2015), “Secular stagnation, debt overhang and other rationales for sluggish growth, six years on”, BIS Working Paper No. 482. http://www.bis.org/publ/work482.htm.
• Reinhart, C. and Rogoff, K. (2009), “This time is different: Eight centuries of financial folly”, Princeton University Press.
• Rogoff, R. (2015), “Debt supercycle, not secular stagnation”, 22 April 2015. www.voxeu.org/article/debtsupercycle-not-secular-stagnation
• Summers, L. (2014), “US economic prospects: Secular stagnation, hysteresis, and the zero lower bound”, Business Economics, vol. 49(2), pp. 65-73.