Wednesday 22 May 2019

Brendan Keenan: 'Ultra-low interest rates are changing the way we live - and borrow'

Harvard Emeritus president Larry Summers has argued that the core of the problem is that there is not enough private investment to absorb all the private saving available
Harvard Emeritus president Larry Summers has argued that the core of the problem is that there is not enough private investment to absorb all the private saving available
Brendan Keenan

Brendan Keenan

It looks more and more as if the biggest change in domestic accommodation in at least a generation is under way. The long trend towards higher rates of home ownership is in reverse.

The housing shortage is usually blamed for the switch from purchase to renting. That is understandable, but events in other countries suggest that, even where there is no great shortage, prices and rents are rising to levels which make it next to impossible for typical workers to buy a home

It was still a surprise to see the same stresses leading to street demonstration in Berlin. Along with Germany as a whole, the city escaped the property hysteria of the 2000s. Now it is happening, along with people being ejected from their homes to make way for tenants who can pay higher rent.

There must be common factors at work everywhere. Finding it in Ireland is made even more difficult by the banking collapse on top of the housing shortage. But we do know one consequence of the crash common to everyone: the persistent, unprecedented low level of interest rates.

It has been going on now for a decade. The US Federal Reserve started early and has been able to restore some semblance of normality. That may reverse if the much anticipated recession takes place. That certainly seems to be the view in the markets.

The Bank of England started early too but has felt unable to threaten fragile economy with rate rises. The ECB started too late but now is not even threatening a rate rise before the end of the year. With rates so low, no one is sure what it, or the Bank of England would do about a recession.

The obvious consequence of such a situation is that anything which generates income becomes more valuable and its price goes up. Rent is one such income. Vulture funds, cuckoo funds, Reits and now the proposed sale of Green - property is still where the action is

Mortgages generate income too, for the lender, and in normal times would be freely on offer in current circumstances. But Irish banks are still constrained and, even more importantly, would-be borrowers are constrained by Central Bank limits. The professional investor or fund gains another advantage over the personal buyer.

The revolutionary switch from the situation where most people own their own home to one where most rent, is well under way. A study last week found that a rise in UK rates to 1.5pc would take £28,000 off the average house price.

But such a rise may not be forthcoming. Some economists are beginning to say that low rates are the new normal. Ireland's laws, politics and social attitudes are not well adjusted to such a normal. Perhaps its fiscal policies aren't either,

One of those who say low rates are here to stay is that dogged critic of austerity policies and conventional theories on debt, Harvard Emeritus president Larry Summers.

In a new paper with former Bank of England official Łukasz Rachel he argues that the core of the problem is that there is not enough private investment to absorb all the private saving available. The result is extremely low rates and inflation, weak demand and poor growth.

That is bad for personal incomes - especially low and middle incomes. At least everyone agrees on that. Last week that doughty supporter of conventional debt theory, the IMF, produced its latest Fiscal Monitor. It included the consequences of declining growth on personal income.

Smoothing out the ups and down by each year taking the average of the previous 10 years, it finds that in advanced economies, not just growth but growth per person (an important distinction), fell from 4pc a year in 1970 to the present 1pc a year.

The figures without the moving average show the Great Recession when, for the first time in 80 years, developed economies shrank in size, and by a catastrophic 4pc at that. Growth has recovered to 2pc, but people are more likely to feel the effects of output being just one per cent higher than in 2008.

This experience, coming after six decades of rising income per capita, remains the most probable explanation for present political discontents, with immigration an added factor. The Summers/Rachel argument is that, with rates of growth and interest near zero, policies have to be quite different than in the past as well.

As well as driving the search for income, ultra-low interest rates encourage borrowing - for those in a position to borrow. Those in the best position to do so are governments. Here, the search for yield, however small, has met the insatiable needs of governments for funds; with cheap debt replacing past expensive stuff and new cheap debt piled on top.

Public debt is now significantly higher than before the crash but it seems a bit cheeky of central banks to complain about it. It would be a strange sort of economics that would expect borrowing to fall as doing it got less expensive. But since the central banks are unable to make it more expensive, they are reduced to just complaints and warnings.

We had better hope, then, that Dr Summers is right. Far from warning, he says that government borrowing is essential if the present "secular stagnation" is not to turn into something worse.

For those who care about such things, he uses the concept of the "natural interest rate", which is the one which matches the amount borrowers wish to raise with what lenders are willing to provide.

The paper calculates that this has fallen by three percentage points in advanced economies over the past several decades, as the amount of savings available for lending has exceeded demand for it.

Government borrowing is a major source of what demand there is. Without it, the paper says, the fall in the natural interest rates might have been seven percentage points, creating even lower growth and higher asset prices.

Finance ministries will quibble with this line of thinking but the other bits of government will argue that it is right, and point to all the things which need more public investment. They will like the argument that nowadays one should talk less about the amount of public debt, and more about its cost as measured by interest payments as a proportion of tax revenue.

Naturally, this has been falling substantially too; down from 9pc of revenues to 7pc, even as debt rose from 70pc of GDP to 105pc. Targeting that figure might indeed make sense. As it happens, the Irish ratio fell below the 7pc average last year. All being well, it should fall further.

All may not be well forever, though. Should the Summers analysis prove wrong, we will find out the hard way. If the world is not in fact completely different, at some point those now lending wherever they can may lose confidence in the credibility of the borrowers. That can happen suddenly and the resulting rise in interest rates would be on levels of public debt not seen outside wartime.

It does not help that more borrowing is going to be needed anyway. To take two examples among many, Ireland faces steep increases in the cost of its state and public sector pensions; Britain faces similar increases in the costs of its health service. Can it really all be done with borrowed money?

There is one point of contact between the debt worriers and the debt pooh-poohers. It is that government borrowings should be used wisely. Summers mentions reducing income inequality and strengthening retirement security - where he is probably thinking about the USA but could just as easily be talking about Ireland.

The IMF stresses cuts to pointless subsidies and restraining permanent expenditures such as wage bills in order to free resources to build infrastructure, meet future costs and improve services, without adding to total debt.

The evidence is that the quality of government spending in terms of boosting growth has declined since the crash. That is not surprising either: what is cheap is rarely valued.

As it happens, the national children's hospital provides an excellent example of both old and new theories at work. In the Summersian view, it does not really matter if the hospital costs an extra billion, or even more. For the IMF, it does. Where they agree is that what matters is the probability that much of the money was wasted and bought the country nothing.

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