Swiss Re Study Highlights ‘Financial Repression’ from Low Rates

Historically low interest rates help finance governments’ debt and lower funding costs, as well as support growth, but such policy actions cause financial repression according to a Swiss Re study.

“Seven years after the financial crisis, central banks are still keeping interest rates at historically low levels,” states the reinsurer’s report, entitled ‘Financial repression: The unintended consequences’. “This comes at a substantial cost for both households and long-term investors such as insurance companies and pension funds.”

Among the findings of the study:

• Since the 2008 crisis, US savers alone have lost roughly US$470bn in interest income.
• 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.
• Financial repression describes official policies directing funds to markets that would otherwise go elsewhere and reduces diversification of funding sources to the economy, representing a risk for financial stability.

Swiss Re adds that 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 USD 470 billion in interest rate income (net) since the financial crisis (2008-2013).

The group has developed a Financial Repression Index, measuring the extent of policymakers’ actions and quantifying the costs of interest rates being at artificially low levels for households and long-term investors. This shows that financial repression remains very high, albeit down from its 2011- 2012 peak. The major driver of change post 2007-08 has been monetary policy.

Swiss Re’s study concludes that keeping interest rates artificially low 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 could repair this damage and address weak economic growth.

“Besides the impact on long-term investors’ portfolio income, the consequence for capital market intermediation is not negligible either,” says Swiss Re’s group chief investment officer, Guido Fürer. “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.”

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, the study finds.

“Future policy actions to create more stable and well-functioning private markets are important for economic growth in the long-term,” adds Fürer.

“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.”