Financial markets have seen a very volatile start of the year so far. Ongoing commodity price weakness and global growth concerns – largely stemming from emerging market economies and China in particular – have been weighing on sentiment. Central banks also continue to play a major role in financial markets. At the end of January, the Bank of Japan (BoJ) introduced a negative interest rate, thereby following the precedent set by a number of European central banks.
Meanwhile, the US Federal Reserve increased its policy rate in December 2015 – for the first time in almost a decade. While some might reason that the recent market turmoil calls for a longer period of zero-rate policy, we argue that this would do more harm than good. There’s no doubt that central banks' actions have helped to prop up the economy in the short-term. However, their unconventional policies also bring along unintended consequences. This includes asset price bubbles, financial market distortions, an impaired credit intermediation channel and increasing economic inequality.
Low interest rates result in a “tax” on savers as they do not earn interest on deposits that they otherwise would. Between 2008-14, US households missed out on around USD 670 billion in interest payments. In Japan and the UK, households were "taxed" by about JPY 105 trillion (approx. USD 900 billion) and £165 billion (USD 40 billion) respectively. During the same period, US insurers lost around USD 250 billion in yield income. This compares to JPY 29 trillion (USD 245 billion) in Japan and £30 billion (USD 45 billion) in the UK. At the end of the day, this results in lower risk capital available to be put to work in the real economy, reducing the diversification of funding sources to the economy and representing a risk for financial stability at large.
Policymakers' actions are becoming ever more dominant role and leading to public ownership of capital markets. This distorts proper financial market functioning. It has weakened the financial market intermediation channel and the positive risk-absorbing role that the insurance sector can play. Structural reforms with innovative private market solutions are required, such as a tradable infrastructure asset class. Policymakers should not fuel further debt build-up and financial market/economic imbalances – they should strengthen private capital market activity.
Learn more about the unintended consequences of financial repression in our factsheet and in-depth publication.
Location: Zürich, Switzerland