When Easy Money Ends
Mareeg.com-LONDON – The departure of US Federal Reserve Board Chairman Ben Bernanke has fueled
speculation about when and how the Fed and other central banks will wind down their
mammoth purchases of long-term assets, also known as quantitative easing (QE).
Observers seize upon every new piece of economic data to forecast QE’s continuation
or an acceleration of its decline. But more attention needs to be paid to the impact
of either outcome on different economic players.
There is no doubting the scale of the QE programs. Since the start of the financial
crisis, the Fed, the European Central Bank, the Bank of England, and the Bank of
Japan have used QE to inject more than $4 trillion of additional liquidity into
their economies. When these programs end, governments, some emerging markets, and
some corporations could be vulnerable. They need to prepare.
Research by the McKinsey Global Institute suggests that lower interest rates saved
the US and European governments nearly $1.6 trillion from 2007 to 2012. This
windfall allowed higher government spending and less austerity. If interest rates
were to return to 2007 levels, interest payments on government debt could rise by
20%, other things being equal.
Governments in the US and the eurozone are particularly vulnerable in the short
term, because the average maturity of sovereign debt is only 5.4 years and roughly
six years, respectively. The United Kingdom is in better shape, with an average
maturity of 14.6 years. As interest rates rise, governments will need to determine
whether higher tax revenue or stricter austerity measures will be required to offset
the increase in debt-service costs.
Likewise, US and European non-financial corporations saved $710 billion from lower
debt-service payments, with ultra-low interest rates thus boosting profits by about
5% in the US and the UK, and by 3% in the eurozone. This source of profit growth
will disappear as interest rates rise, and some firms will need to reconsider
business models – for example, private equity – that rely on cheap capital.
Emerging economies have also benefited from access to cheap capital. Foreign
investors’ purchases of emerging-market sovereign and corporate bonds almost tripled
from 2009 to 2012, reaching $264 billion. Some of this investment has been initially
funded by borrowing in developed countries. As QE programs end, emerging-market
countries could see an outflow of capital.
By contrast, households in the US and Europe lost $630 billion in net interest
income as a result of QE. This hurt older households that have significant
interest-bearing assets, while benefiting younger households that are net
Although households in many advanced economies have reduced their debt burdens since
the financial crisis began, total household debt in the US, the UK, and most
eurozone countries is still higher as a percentage of GDP (and in absolute terms)
than it was in 2000. Many households still need to reduce their debt further and
will be hit with higher interest rates as they attempt to do so.
Some companies, too, have been affected by QE and will need to take appropriate
steps if such policies are maintained. Many life-insurance companies and banks are
taking a considerable hit, because of low interest rates. The longer QE continues,
the more vulnerable they will be. The situation is particularly difficult in some
European countries. Insurers that offer customers guaranteed-rate products are
finding that government-bond yields are below the rates being paid to customers.
Several more years of ultra-low interest rates would make many of these companies
vulnerable. Similarly, eurozone banks lost a total of $230 billion in net interest
income from 2007 to 2012. If QE continues, many of them will have to find new ways
to generate returns or face significant restructuring.
We could also witness the return of asset-price bubbles in some sectors, especially
real estate, if QE continues. The International Monetary Fund noted in 2013 that
there were already “signs of overheating in real-estate markets” in Europe, Canada,
and some emerging-market economies. In the UK, the Bank of England has announced
that in February it will end its mortgage Funding for Lending Scheme, which allowed
lenders to borrow at ultra-low rates in exchange for providing loans.
Of course, QE and ultra-low interest rates served a purpose. If central banks had
not acted decisively to inject liquidity into their economies, the world could have
faced a much worse outcome. Economic activity and business profits would have been
lower, and government deficits would have been higher. When monetary support is
finally withdrawn, this will be an indicator of the economic recovery’s ability to
withstand higher interest rates.
Nevertheless, all players need to understand how the end of QE will affect them.
After more than five years, QE has arguably entrenched expectations for continued
low or even negative real interest rates – acting more like addictive painkillers
than powerful antibiotics, as one commentator has put it. Governments, companies,
investors, and individuals all need to shake off complacency and take a more
disciplined approach to borrowing and lending to prepare for the end – or
continuation – of QE.
Richard Cooper is Professor of International Economics at Harvard University.
Richard Dobbs is a director of the McKinsey Global Institute.