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Stagnation shouldn’t be the “new normal”
The latest World Economic Outlook published by the International Monetary Fund includes a mind-blowing chapter on the perspectives of global real interest rates. Generally speaking, interest rates adjusted by inflation have strongly declined since the 1980s. Ten year bond rates have dropped from a peak of roughly 12% per year in the 1980s to a lower bound close to zero in recent years.
To a large extent, a more integrated economy and financial sector have generated global influences responsible for the decline in real interest rates. In fact, contrary to our intuition, the recent global financial crisis played only a marginal role in the real interest rate decline.
Briefly, global real interest rates have been battered from all sides by an unsynchronized combination of fiscal tightening and aggressive monetary policies adopted by a large number of countries in the 1980s and 1990s. The combination of these global influences drove down real rates in an unexpected way over decades.
Additionally, and more importantly, the IMF estimates a global mismatch between savings and investment rates which have contributed to a fall in the real interest rates. The savings rates in emerging economies have gone up more than proportionally to their investment rates. The excess saving, which have not been invested in the economy, had been transferred to the financial markets of developed economies, seen as a “safe heaven” by investors from emerging economies. With rates of investment in developed economies falling a long way, the excess saving transferred has never been invested in the real side of the economy. The situation has generated a global oversupply not matched up by investment demand that fuelled consumer debt-led growth in a large number of developed economies, including the United Kingdom and the United States. Now, it is time to flip the coin in the opposite direction by increasing the public investment in the real economy and reap the benefits of low interest rates.
Britain is rightly proposing a £21bn (US26.4bn) public investment for the construction of its first high speed rail (HS2) connecting London to cities in the North of the country and, consequently, changing the economic geography of the United Kingdom. The British government is benefiting from historically low interest rates to finance its expenditure, including HS2. Other European countries, contrary to the European commission budgetary restrictions, should tap into the availability of cheap money to develop their future infrastructure and fight against stagnation.
Want to learn more about the economic situation in countries across the globe? Click here for our comprehensive list of PESTLE insights.