A study, – “Financial repression: The unintended consequences -” released by Swiss Re, notes that “seven years after the financial crisis, central banks are still keeping interest rates at historically low levels.” They keep them low as the policy helps to “finance governments’ debt and lower funding costs, as well as support growth.
“But such policy actions cause financial repression,” Swiss Re said, which exacts a “substantial cost for both households and long-term investors such as insurance companies and pension funds. With continued increases in bond prices, expensive stocks and relatively low volatility, the impact of financial repression on markets is undisputable. Meanwhile, the impact of foregone interest income for households and long term investors has become substantial: in the US alone, savers have lost about $470 billion in interest rate income (net) since the financial crisis of (2008-2013).”
Swiss Re also indicated that “artificially low interest rates that go with financial repression lower incentives for policymakers to tackle much needed structural reforms in Europe. Other unintended consequences of financial repression include potential asset bubbles, crowding out long-term investors in otherwise functioning private markets, increasing economic inequality and the potential of higher inflation over the long-term besides distorting private capital markets.”
In addition the report found that since the start of the financial crisis, “EU and US insurers have lost around $400 billion in yield income. This currently corresponds to an annual ‘tax’ of roughly 0.8 percent of total financial assets on average, lowering long-term investors’ capacity to channel funds to the real economy.”
Swiss Re’s Group Chief Investment Officer, Guido Fürer, explained: “Besides the impact on long-term investors’ portfolio income, the consequence for capital market intermediation is not negligible either. Crowding out investors due to artificially low or negative yields will reduce the diversification of funding sources to the real economy, thus representing a risk for financial stability and economic growth potential at large.”
The figures cited in the report were determined by Swiss Re’s own index, the first of its kind to “measure financial repression.” It also concludes that “financial repression remains very high, albeit down from its 2011-2012 peak. The major driver of change post 2007-2008 has been monetary policy.”
The findings are significant, as “long-term investors are part of the intermediation channel that helps move saving funds to the real economy. In Europe alone, insurance companies have roughly $9.5 trillion in assets under management, amounting to about 60 percent of European long-term investments funds available,” the report said.
As a result, keeping interest rates at artificially low levels through official intervention “hampers the ability of long-term investors to deploy risk capital into the real economy. It has broken the financial market intermediation channel by crowding out viable private markets, lowering the funds available from long-term investors to be used for the real economy.” Investments in infrastructure, area prime example. They “could repair this damage and address weak economic growth.”
Swiss Re explained that “policymakers face a trade-off between supporting the economic recovery and contributing to the further potential build-up of financial and economic imbalances.” Their action in lowering yields distorts private market signals, as “financial repression serves as a disincentive for governments to tackle pressing public policy challenges and thus advance the structural reform agenda.
“The longer such extraordinary and unconventional monetary policies are in place, the more challenging the exit phase will be. The increasing role of public versus private markets spurs economic and financial market imbalances, representing key vulnerabilities for the long-term stability of well-functioning financial markets.”
The report adds, however, that “financial repression is likely to remain a key tool for policymakers given the moderate global growth outlook and high public debt overhang. Whether the costs outweigh the benefits largely depends on the ability of governments to take advantage of the low interest rate environment by implementing the right structural reforms. So far the record for doing so hasn’t been comforting.”
In conclusion Fürer said: “Future policy actions to create more stable and well-functioning private markets are important for economic growth in the long-term. That said, today’s environment already provides a great window of opportunity, particularly in the area of infrastructure investments. Here we need a tradable infrastructure debt asset class so we don’t have to rely on the public sector for investments. Instead, the public policy environment should promote a well-functioning private infrastructure debt market.”
Source: Swiss Re
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