Permanently low interest rates and weak government decisions are destroying investment and savings and damaging economic growth, warns the Organisation for Economic Co-operation and Development (OECD)
The OECD’s annual business outlook says that low interest rates were introduced as a boost to economies in crisis but over long periods of time, they have hurt advanced economies.
According to the OECD’s Business and Finance Outlook 2016, the slump in commodity prices – which has hurt Australia – has been driven by China but the low level of growth is the result of the still lingering after-shocks of the financial crisis and low or negative interest rates combined with re-regulation.
The report says monetary policy easing has “reached its limits.”
“Quantitative easing and low-interest-rate monetary policy can do little to correct over-investment in global industrial sectors,’’ the report says.
“At this point, such policies may be harming the prospect of a sustainable recovery.”
The OECD’s warnings are critical with the Reserve Bank of Australia expected to cut interest rates again in August and the United States Fed trapped in a near zero interest rate policy.
It says low interest rates result in investor “short-termism” which is bad because “innovation and productivity growth requires the financing of long-term risk taking in capital expenditure and its financing.”
Also, low interest rates encourages companies to take on too much debt, says the OECD. The allow companies to borrow to fund share buybacks, and engage in unproductive investments that are “based on a distorted cost of capital while waiting for the tide of aggregate demand to rise.”
This creates irrational behaviour in markets.
“Investors have been herded into concentrated trades, many of which are illiquid, and recent volatility reflects periodic attempts to exit them – particularly when there is any hint of a withdrawal of the monetary policy ‘morphine’ to which they have become addicted,” the report said.
The problem for central banks, says the OECD, is that once they have introduced zero to low interest rates, they struggle to get them back to normal levels.
“Financial fragility means that central banks will embark upon the normalisation of interest rates only very slowly and the outlook for the next year or two in financial markets is one of choppiness about [a trend of modest returns], with persistent risks of extreme volatility,” says the OECD.
“Seven years of extremely easy monetary policy has not restored the investment and productivity growth needed to raise income per head, real wages, demand and growth,” said the OECD.
“This policy was originally designed to stabilise the financial system and support economic recovery, but somehow has slipped into.” trying to compensate for the other policies that are needed.
What’s needed, the OECD says, is governments to allow bad companies to go bust, encourage banks to write off bad loans and encourage innovative firms to grow by investing in new growing industries, such as renewable electricity, as the commodity “supercycle reverses.”
The OECD however does not see that happening any time soon. As a result, the global economy is left trapped in a cycle of low interest rates and low productivity growth.
“Unfortunately structural reform on the scale required is unlikely in the near term,’’ the OECD says. “This means that creative destruction and a lift-off in rates is postponed. Central banks are most likely to continue with low interest rates and the quantitative easing approach.”