All this bears directly upon a big question for savers: will interest rates ever rise? It could be that one reason for low rates is that the great recession of 2008-09 has left permanent scars. I mean this in two separate senses.
In financial markets, it has led to increased demand for cash and safe assets. The question: “why hasn’t massive printing of money led to inflation?” has a simple answer: it’s because there’s been an increased demand for cash (and other safe assets) to match the increased supply. In much of Europe, investors are content to pay governments to store their cash: this is what negative yields mean. In the UK, record-low rates are accompanied by price-earnings ratios on non-financial shares that are still below post-1990 averages. And, despite low interest rates, UK companies are still piling up cash and paying down debt.
One obvious explanation for these patterns is that the financial crisis has increased risk aversion. Slightly negative bond yields aren’t so unattractive if you believe there’s a danger of massive losses elsewhere. Modest equity valuations and low returns on cash won’t boost stock markets if investors are risk-averse. And if companies don’t trust banks to maintain credit lines, they’ll not borrow to expand for fear of seeing credit withdrawn in bad times. As Biagio Bossone, chairman of the Group of Lecce, says, the recession has led to firms wanting to hold liquid assets rather than invest in capital.
This risk aversion means that low interest rates are not having the effects that cheap money usually does: they’re not leading to speculative bubbles in equities or to booms in capital spending. And this in turn means low rates are sustainable.
There is, a second sense in which we might be seeing a scarring effect of the recession – in the labour market. Last week Andrew Haldane, the Bank of England’s chief economist, said that “wage growth has consistently and significantly undershot its expected path.” There are several reasons why this might be – for example, immigration and the large number of older people entering the labour market means there’s more excess supply of labour than unemployment figures would suggest. One reason, though, might be simple fear. Memories of the recession have made workers scared to use their increased bargaining power to ask for pay rises. With wage inflation low, there’s no need for higher interest rates.
There’s a precedent here. In the 1950s, policy-makers were surprised that full employment did not trigger wage inflation. One reason for this was that memories of the Great Depression scared workers into accepting low pay despite an objectively strong bargaining position.
It’s possible, therefore, that the financial crisis has had long-lasting effects. In raising risk aversion, it’s made ultra-low interest rates sustainable.
This could last a long time. But not, perhaps, forever. Eventually, memories of the recession will fade. When they do, risk aversion should fade. This might, however, take a long time.
