Should egalitarians fear low interest rates?

Monetary stimulus is said to have been a boon for the rich. It is not so simple

JOHN MAYNARD KEYNES once fantasised about a world of permanently low interest rates. In the final chapter of “The General Theory” he imagined an economy in which abundant available capital causes investors’ bargaining power, and hence rates, to collapse. In such a world markets would reward risk-taking and entrepreneurial talent, but not the mere accumulation of capital. The result would be the “euthanasia of the rentier”.

That low rates could feature in a leftish Utopian vision might come as a surprise today. It is commonly argued that a decade of monetary-policy stimulus has filled the pockets of the rich.

Low rates and quantitative easing (QE) are said to have sent stock and bond markets soaring, thereby exacerbating wealth inequality. They have also boosted house prices, adding to intergenerational tension. A glance at financial markets suggests more of the same is coming: long-term rates have tumbled this year in anticipation of monetary easing, while stockmarkets have boomed.
Central bankers have defended their policies by arguing that, without loose money, unemployment would have been much higher, badly hurting the poor. That is true. But the effect of monetary stimulus on financial markets has nonetheless angered left and right alike.

Judy Shelton, one of President Donald Trump’s new picks for the board of the Federal Reserve, has blamed central banks for “exacerbating income inequality”. She has called for a return to the gold standard. The left, meanwhile, prefers fiscal loosening such as giving money to the poor, or fiscal-monetary hybrids such as the “people’s QE” once advocated by Jeremy Corbyn, the leader of Britain’s Labour Party, under which the central bank would finance government investment.

Who is right? Do low rates spell euthanasia or euphoria for those who live off capital? And should concerns about inequality determine which policy lever to pull in a downturn?

A starting-point is that falling interest rates make all streams of future income more valuable.

That includes dividends from stocks, coupons on bonds and homeowners’ privilege of being able to occupy their houses without paying rent. But the resulting increases in asset values can be captured easily only by people who are willing to change their plans.

Imagine a homeowner. A higher house price is of little benefit to him if he has no desire to sell and move. Similarly, a bondholder about to retire may need the steady stream of coupon payments the bond provides. A capital gain from selling bonds today might fund a lavish around-the-world cruise, but blowing through retirement funds is unlikely to be prudent.

Now consider a penniless millennial. She sees no capital gain when low rates boost asset prices.

But she does have assets that will yield income in the future: education and skills. Were this human capital valued on financial markets, it too would rise in value when interest rates fall.

She too could change plans and spend more today, but by borrowing cheaply rather than selling assets.

A recent paper by Adrien Auclert of Stanford University sets out a framework for judging who wins and who loses from changes in monetary policy. Three channels must be considered. One concerns the impact of lower rates on the macroeconomy—the effect trumpeted by central banks. Another concerns the higher inflation that lower rates might cause. That hurts creditors and benefits debtors, who see the real value of their obligations shrink.

The third channel concerns asset prices. It is wrong to claim that asset-holders generally benefit when rates fall, says Mr Auclert. What matters is the full picture of an individual’s assets and liabilities. The latter he defines to include future consumption plans (such as whether the homeowner wants to stay in his house, or whether the retired person seeks to maintain a steady standard of living). Only by looking at an individual’s balance-sheet in full can you judge whether he wins or loses from low rates—or whether, in the jargon, he has “unhedged interest-rate exposure”.

The crucial question is whether someone’s assets and liabilities mature at different points in time. People with short-dated assets but long-dated liabilities—for example a saver with lots of cash in the bank to fund a purchase ten years hence—do badly when rates fall. They are the euthanised “rentiers”, who must save more to fund spending later (a rare example of lower rates depressing consumption). But those who wish to spend today and hold long-dated assets, such as long-term government bonds, do well.

What does this framework imply for rich and poor? Mr Auclert presents some evidence that Americans who are older, or whose incomes are higher, tend to be on the losing end of asset-price effects when rates fall. But he says it is hard to measure the effect precisely. A recent working paper by Panagiota Tzamourani of the Bundesbank finds that within the euro area, average unhedged interest exposure varies a lot between countries, seemingly in line with the prevalence of floating-rate mortgages. But Ms Tzamourani also finds that younger households and those with low net wealth benefit from lower rates almost everywhere.

Good hedges make good neighbours

That seems to turn conventional wisdom on its head. Far from helping the well-heeled, the changes to financial markets induced by low rates could be hurting them, just as Keynes argued. Some might object that they do not deserve the hit: surely those who save in cash for future consumption are more responsible than those who wish to borrow and spend? Keynes would have retorted that in a world awash with capital, extra saving does not benefit society. In a slump it is harmful. In any case, if fiscal stimulus is preferred to low interest rates, taxpayers would end up with debts instead.

Monetary stimulus may not help the poor as much as deficit-financed welfare or progressive tax cuts. Structural problems in the economy, such as market power, may allow the rich to earn high returns even as rates fall. But egalitarians—and those without wealth—probably need not fear doveish central banks.


“Monetary Policy and the Redistribution Channel”, by Adrien Auclert, American Economic Review, June 2019
“The interest rate exposure of euro area households”, by Panagiota Tzamourani, Deutsche Bundesbank Discussion Paper, January 2019

China’s Financial Plumbing Is Getting Leakier

Money-markets ructions expose a vulnerability that still hasn’t been patched: dependence on low-quality collateral

By Nathaniel Taplin

Markets are a psychological phenomenon—a set of beliefs about how the world works and what things are worth. When assumptions are challenged, the results can be stomach-churning.

Unnoticed by most of the world, this is what happened in China last month. After regulators took over a small bank called Baoshang—and upended assumptions of state backing by announcing probable haircuts for creditors—short-term borrowing rates spiked. The episode laid bare the fragility of China’s gargantuan interbank money market, whose daily transactions come to about 3.3 trillion yuan ($479 billion).

It also highlighted a vulnerability that still hasn’t been patched: Some nonbank financial institutions—a category that includes brokerages, insurers, funds and shadow banks like trusts—appear too dependent on low-quality collateral such as corporate bonds to backstop short-term borrowing. This raises risks for China’s money markets and struggling corporate borrowers alike.

After big cash injections by the People’s Bank of China, average short-term borrowing costs in China’s money markets fell sharply. But some individual lenders still are charging usurious rates. On Friday, the closing rate for the 21-day collateralized interbank repo was 10%. A day before, the one-month repo closed at 18.5%—a universe away from the weighted average rate, which was below 3%.

One little bank takeover, and suddenly a lot of assumptions go up in smoke. Photo: china stringer network/Reuters

These are the aftershocks of June’s monetary earthquake. In the midst of the panic, some lenders nearly stopped taking corporate bonds as collateral at all. Nonfinancial corporate bonds are a small portion of overall interbank repo collateral—government and policy-bank bonds accounted for close to 90% in 2016, according to the Reserve Bank of Australia. But when much of the remainder became useless overnight, it was enough to cause major problems.

Worryingly, just as money markets are getting twitchy, corporate creditworthiness is getting more precarious. There were more than twice as many bond defaults in the first half of 2019 as a year earlier, according to Enodo Economics. Next time money markets get spooked, corporate-bond collateral may look even more dubious, and authorities may have to intervene even more forcefully to reassure lenders.

Alternatively, interbank borrowers may now try to wean themselves off all but the highest-rated bond collateral. There are already hints of this: The yield premium of three-year AA-rated medium-term notes over their AAA counterparts has widened by about a fifth of a percentage point since late May, according to Wind, after narrowing continuously for most of the year.

By making credit less accessible to embattled small companies, this could ultimately mean a weaker recovery, or that more-aggressive monetary policy is necessary to turn things around. At the very least, the reverberations from the regulatory takeover of Baoshang Bank will be around for a while. The next time money markets panic about counterparty risk, it might be even tougher to calm them down.

Firefighting — Bernanke, Geithner and Paulson reflect on the financial crisis

Top policymakers look back on lessons learnt and mistakes made during 2008 meltdown

Martin Sandbu

From left: US Treasury secretary Henry Paulson, Federal Reserve chairman Ben Bernanke, and president and chief executive of the Federal Reserve Bank of New York Tim Geithner in 2008 announcing that the Treasury Department will take equity stakes in banks totaling about $250bn © Reuters

The authors of Firefighting undeniably have a tale to tell. They held America’s highest economic policymaking offices during the global financial crisis — Ben Bernanke as Federal Reserve chairman, Henry Paulson as the Bush administration’s last Treasury secretary (and before that a Wall Street chief executive), and Tim Geithner as president of the New York Fed and then Paulson’s successor in the Obama administration.

This is the inside story, 10 years on, of how America’s top policymakers tried to contain a financial implosion that threatened to send not just the US but the whole world into a replay of the 1930s Great Depression. Beyond historical interest, the authors insist that without understanding the steps they had to take, we risk being unprepared next time a crisis hits.

Those who want to understand how the US financial system could suddenly collapse, taking seasoned policymakers like these three by surprise, could do a lot worse than this book.

Firefighting is mercifully short and succinct, yet all the key elements of the chronicle are here: the ballooning borrowing and blinding complexity of the boom in mortgage-backed securities, the legally creative Fed loans into frozen markets, the expanding schemes to prop up asset prices, the capital injection and stress tests for banks that calmed investors and the huge fiscal and monetary stimulus that put the economy back into gear.

The book is also surprisingly well-written — not always a given when technocrats and wonks take to the keyboard. Apart from slightly overworking the metaphor in the book’s title, whoever penned the words avoids getting bogged down in technical details and keeps the pace with some felicitous turns of phrase (“The Wild West with better plumbing was still the Wild West” is the verdict on the meagre regulatory efforts before the crisis).

However, for those who followed the crisis more closely the interest does not lie in new information, of which there is really none, but in how the authors assess their own efforts with the benefit of hindsight. Needless to say, they think they got it mostly right, while honourably admitting they had to scramble and improvise given the opacity of the financial sector when the crisis started and the speed at which previously unthinkable events unfolded.

Their overarching imperative was to arrest the financial panic by restoring confidence that US financial institutions could honour their obligations. Put another way, they saw it as the government’s responsibility to forestall as far as possible the propagation of losses through the financial system. They largely avoid the term “bailout”, but that was clearly the policy they pursued. Not, admittedly, without dismay: the authors express their deep dislike of taxpayer support for banks, but argue that in a financial panic, the normal rules do not apply.

So when they hit back at critics who said they should not have let Lehman Brothers go bankrupt they do not challenge the premise that the bank should have been saved — they just claim they did not have the legal powers to do so. But they offer precious little argument to those who think the government was too quick to put all institutions in the “must be saved” category.

In effect, the authors assert that in a crisis, all private financial debt must be treated as the government’s responsibility. By their own admission, they went beyond Walter Bagehot’s rule for stopping liquidity crises: lend freely but at penalty rates, to solvent borrowers and against good collateral only.

Their view that government should prevent losses for banks’ creditors to the fullest extent possible puts Bernanke, Paulson and Geithner in opposition to a person they unfairly relegate to a bit player in the book. That is Sheila Bair, the chair throughout the crisis of the Federal Deposit Insurance Corporation — the agency President Franklin Delano Roosevelt created to wind up failed US retail banks while guaranteeing deposits. Only a few days after Lehman’s collapse, the FDIC wound down Washington Mutual, one of the country’s biggest mortgage lenders. Depositors were protected but other creditors forced to take losses. The authors claim this triggered deposit flight from Wachovia but offer no evidence it could otherwise have stayed out of trouble. It is too easy, given the financial storm that was happening, to blame Wachovia on Bair being more sceptical of bailouts than they.

Whether to try to make private investors share in the losses of banks was the most important divide in the administration. Bair also insisted, for example, that a new guarantee of broad bank liabilities (which the authors pushed her to accept) should only apply to new contracts, not old debt, in an attempt to support new lending to solvent borrowers without saving banks for their past mistakes. This, too, they disliked.

Even as they pick at the FDIC’s wind-down of retail banks, the authors complain there was no resolution regime for the bigger financial companies on their watch. Creating such a regime has since been central to efforts to end the problem of banks that are too big to fail. But they do not seem to have asked for one in the stressful days of 2008 when they were banging down the doors on Capitol Hill to lobby for greater powers. Why did they not ask for resolution powers, which would have allowed them to split up such a bank as Lehman and write down some of its liabilities but not others? They do not tell us, but the answer that presents itself is that this was an authority they did not want to wield.

This deference to Wall Street comes up elsewhere, too. They lament that they did not think they could force financial companies to increase equity capital above the regulatory minimum. Why did they then not raise the regulatory minimum? They do not say. They report leaving 20.1 per cent of insurance company AIG in the hands of its private shareholders because taking more would “force the government to bring the company formally onto its balance sheet”. They do not say why this would be a bad thing.

No doubt these policymakers did a solid job in extraordinarily challenging circumstances. Their policies worked, and they worked rather well. But they were not the only policies available, nor do their choices have a strong claim to being the best ones; bank bailouts have after all fuelled populism. What they do not seriously consider is whether their policies to restart credit flows could have worked even with a less bailout-friendly approach, saving both money and political anger. These are the ideological blind spots revealed by reading Firefighting between the lines.

Firefighting: The Financial Crisis and Its Lessons, by Ben Bernanke, Tim Geithner and Henry Paulson, Penguin, RRP$16, 240 pages

Martin Sandbu is the FT’s European economics commentator

The Value of Global China

At a time when the risks of international engagement are more obvious than ever, China faces important questions about whether – and to what extent – it should continue to pursue opening up its economy to the rest of the world. At stake may be some $22-37 trillion in economic value – or 15-26% of world GDP – by 2040.

Jonathan Woetzel , Jeongmin Seong


SHANGHAI – Over nearly 40 years of economic reform, China has reaped extraordinary rewards from opening up to the world. Integration into the global economy – albeit a supporting element of the country’s broader historic turn to the market mechanism – has enabled millions of China’s citizens to escape poverty, while transforming China into the world’s largest economy in purchasing power parity terms. And the potential of such engagement is far from depleted, our new research shows.

For example, while China commands 11% of global merchandise trade, it accounts for only 6% of global trade in services. Moreover, while China’s banking, securities, and bond markets all rank among the world’s top three in size, foreign entities account for less than 6% of their value. And though China has 110 Global Fortune 500 companies, less than one-fifth of their revenue is earned overseas, compared to 44% for S&P 500 firms.

Even before today’s trade tensions, the relationship between China and the world had been changing. China’s relative exposure to the rest of the world – in terms of trade, technology, and capital – peaked in 2007, and has been declining ever since, producing an overall decline from 2000 to 2017. This partly reflects the economy’s growing emphasis on domestic consumption – a trend that accelerated after the global financial crisis sharply reduced foreign demand for China’s exports.

Over the same period, however, the rest of the world’s exposure to China increased, highlighting the country’s growing importance as a market, supplier, and provider of capital.

This divergence arguably reflects the unbalanced dynamic that is fueling trade tensions with the United States. The sheer scale of China’s impact may also be a factor. Closer economic ties with the world have fueled China’s growth, as the country learned best practices from global players and provided cost-competitive products. But there have been losses, too, notably in the form of manufacturing jobs in both China and advanced economies.

In any case, China and the world face important questions about the trajectory of their mutual engagement. At stake, according to our simulation, may be some $22-37 trillion in economic value – or 15-26% of world GDP – by 2040. We note that these estimates are the result of a simulation based on a specific set of conditions and assumptions, and they should not be taken as forecasts. For example, for the scenarios, we have made assumptions about how various factors could affect the economy’s total factor productivity.

Our analysis is sensitive to the degree of liberalization that would occur in the Chinese services sector, increases in capital productivity as a result of greater financial globalization, and productivity improvements from technology transfer. The simulation focuses on long-term impact. We are not attempting to predict the outcome of current debates on trade and tariffs.

While less predictions than possibilities, our simulation provides insight into the implications of the choices for China and the world in five key areas.

1. Growth as an import destination: China may either pull back from international trade, and the world may fail to reform the multilateral trading system, causing total global trade flows to decline. Conversely, China could push forward, establishing itself as a major destination for exports from emerging and advanced economies. The total value at stake, according to our simulation, is $3-6 trillion between now and 2040.

2. Liberalization of services: China may maintain current restrictions on its services sector, which create a productivity gap vis-à-vis the developed economies, or it could roll back these restrictions, attracting more foreign players and thus boosting the sector’s growth and global competitiveness. Here, $3-5 trillion could be at stake.

3. Globalization of financial markets: China and the world can integrate their financial markets, thereby broadening investor choice and improving capital allocation, or they can maintain the status quo, risking more volatility and low productivity growth. We estimate that $5-8 trillion of value could be at stake.

4. Collaboration on global public goods: Global challenges, such as climate change, and provision of adequate public goods, such as infrastructure, depend on China and the world collaborating. Greater or less collaboration could put about $3-6 trillion of value at stake, and potentially much more, as climate change’s impact is likely to be much greater after 2040.

5. Flows of technology and innovation: Increased technology (and knowledge) flows between China and the rest of the world would support the development of globally competitive, productivity-enhancing solutions; decreased flows would undermine global productivity. The world can also decide how to facilitate more or fewer flows of technologies that are increasingly subject to security reviews. According to our simulation, $8-12 trillion could be at stake, depending on the extent to which technology flows unleash innovation and productivity growth.

It is important to note that these choices are not just China’s; the world also has decisions to make. For example, by working together to reform the global trading system in ways that strengthen dispute resolution and boost inclusiveness, countries could ensure that the benefits from increased Chinese (and other) trade are shared broadly.

Furthermore, if China moves to globalize its financial sector further, the rest of the world must be open to Chinese investment. And, of course, all countries should play a role in delivering global public goods; on climate change, in particular, they must commit to reaching specific milestones in line with their capabilities and their contributions to the problem. Finally, countries should ensure that their trade and investment policies are conducive to continued transfer of technology and knowhow.

There is still much to be gained from China’s continued integration into the global system. The question is whether world leaders will do what it takes to bring about that outcome. All sides should now take a breath and try to figure out where and how to advance further integration, and how to deal with the more complex or contentious aspects of that challenge.

Jeongmin Seong is a senior fellow at the McKinsey Global Institute in Shanghai.

Jonathan Woetzel is a McKinsey senior partner, a director of the McKinsey Global Institute, and co-author of No Ordinary Disruption: The Four Global Forces Breaking All the Trends.