Zero Rates Are Destroying the Market Economy

Here we go again. The US Federal Reserve is cutting rates again. The European Central Bank has recently indicated that easier monetary policy is on its way. The entire German government yield curve, including the 30-year bond, is now trading with negative yields. If a year ago, half the world’s central banks were raising rates, now all have stopped and nearly half of them are already reducing interest rates again.

In recent years, there were grounds to believe, or at least to hope, that perhaps we are moving away from the zero-rate environment we had entered following the 2008 financial crisis. Between 2016 and 2018, the US Fed raised the Fed Funds Rate to 2.50% from 0.25%. Other central banks followed. However, it now seems that this was temporary and that we are now falling back – perhaps even harder – into the zero-rate trap.

Sir Winston Churchill famously said that Democracy is the worst form of government except for all the others that have been tried. Similarly, we can say that Capitalism, or the Market Economy, is the worst economic system aside from all the others that we are familiar with. It has its flaws, but also many advantages.

Zero rates are now destroying the market economy. Low interest rates have helped cushion the economic downturns and have enabled borrowers to kick the debt can further down the road. However, in the long term, we are all going to pay a price for this. Zero rates will hurt savers and pensioners. We could see a big savings crisis. As already widely noted, zero rates are also further deepening inequality within society. It helps those who own financial assets whose value has been boosted by lower rates but hurts the average saver who relies on bank deposits. The zero-rate environment not only promotes inequality between individuals, but also between firms. Larger firms with good access to capital markets are benefitting disproportionately from low interest rates. I do not subscribe to the view that economic inequality in itself is a moral problem. I believe that there is moral value in that everyone has enough (to survive, live decently, etc.) but not necessarily the same. Having said that, inequality leads to less social solidarity, and at the extreme could lead to social and political instability that is undesirable.

Given our experience of recent years, it seems that monetary policy alone cannot deliver sustainable global growth. Although the objective of easier money is to support investment and consumption, it is possible that around the zero bound, interest rates no longer function in this direction. In this sense, the pressure applied by President Trump on the US central bank to reduce rates is short-sighted. It is making our big problem – our inability to move away from zero rates – much worse. His time might be better spent contemplating and planning growth-promoting economic reforms.

The challenge of escaping the current economic and monetary environment now falls on governments. Central banks have tried and failed. And yes, it will require a long-term perspective. Governments need to quickly come up with market reforms that will remove barriers to business, increase competition -- in order to unleash growth. They need to examine their roles in making investments and how they can encourage others to do so. This is the only way in which we may be able to escape the zero-rate environment that is becoming so destructive from both economic and social perspectives.