Could low interest rates be causing low growth?
Declining interest rates have been a semi-permanent feature of the global economy since the 1980s. In that time the long-term interest rate has trended downwards from 4 percent to almost zero. The pandemic-induced recessions around the world have encouraged central backs to reduce rates further with even some emerging economies using quantitative easing for the first time.
Despite maintaining ultra-low rates for many years central banks have struggled to boost global economic growth which the IMF warned in 2019 was in a “synchronised slowdown”. Rather than stimulating growth as conventional wisdom suggests, there is increasing concern that the persistently low interest rates may in fact be causing the low growth.
Interest Rates New Zealand
A well-functioning economy allows for companies to both exit and enter. However, according to William White, former economic adviser at the Bank for International Settlements easy monetary conditions discourage these processes from work effectively. As a result, both liquidations and company start-ups have fallen sharply in many countries in recent years alongside productivity.
Low rates can also encourage the development of so-called “zombie companies” — highly indebted firms that are propped up by cheap borrowing but act as a drag on economic growth over the long term.
Competition and Market Concentration
In New Zealand, access to capital has been a central theme for those concerned about the country’s persistently low productivity growth — thin capital markets, a traditional banking sector and effective duopolies in many industries have all been cited as contributory factors. But could our decades-long decline in interest rates also explain our poor productivity performance and low GDP per capita?
Recent research by E. Liu and A. Mian from Princeton and A. Sufi from the University of Chicago suggests that while low interest rates have traditionally been viewed as a good thing for economic growth, at a certain point they may actually slow growth by increasing market concentration and monopolies.
The traditional view has been that when long-term rates fall it encourages firms to spend more today on technologies that enhance productivity, boosting growth. However, it seems that when interest rates are already very low, further reductions can also have the opposite effect — reducing the incentive for firms to invest in productivity-enhancing technology. This contractionary effect is caused by industry competition. While low interest rates encourage all firms in an industry sector to invest more, market leaders have even more incentive to do so as the “prize” is gaining an outsized control of the market. As a result, industries tend to become more monopolistic over time, reducing competition and ultimately long-term rates.
Liu, Mian and Sufi’s analysis suggests this contractionary effect helps to explain many global economic trends since the 1980s: growing market concentration, rising corporate profits, weaker business dynamism, declining productivity growth and rising inequality. Their analysis suggests that additional cuts to interests rates off a very low base will hurt the economy even further by increasing market concentration and reducing productivity growth.
Cause or Effect?
But are low interest rates the cause or the effect of low economic growth? Economist Robert Gordon argues in his 2014 book The Rise and Fall of American Growth that declining interest rates since the 1980s have been the effect of low productivity growth. The cause for this has largely been technological. Gordon suggests that the third industrial revolution of computers and digitalization has been less important than the second industrial revolution. Not only has growth been slower since 1970 than previously, but the improvements in everyday life are less profound than the benefits of the industrial revolution.
Harvard professor N. Gregory Mankiw in a New York Times article makes a similar point, suggesting that while old-world technologies like railroads were capital intensive, new technologies require smaller capital investments. This reduced demand for capital, in turn, depresses interest rates.
Whether low interest rates are the cause, effect, or even in a circular relationship with growth, there is increasing concern that persistently low interest rates may be doing more harm than good. Not only do they lead to debt accumulation and increasing asset prices, but they may ultimately be damaging our economy by limiting its ability to grow.