SPEECH
ULTRA LOW INTEREST RATES FROM THE
PERSPECTIVE OF A CENTRAL BANKER, OPENING
REMARKS BY GOVERNOR LARS ROHDE AT THE
CONFERENCE 'LONG RUN OUTLOOK FOR
INTEREST RATES', 1 SEPTEMBER 2021.
CHECK AGAINST DELIVERY
Good morning. In my remarks today, I will explore the topic of low
interest rates from a Danish perspective. I hope that this will set the scene for
today's discussions in what will surely be a very fruitful conference.
The persistent decline in a wide set of interest rates is one of the most
important topics in modern macroeconomics and finance. It is driven by a
host of underlying factors operating at a global level, and it has
implications for households, firms and financial institutions of all shapes and
sizes.
The decline in interest rates is also affecting the scope for conducting
economic policies. Most obviously, it challenges the effectiveness of
conventional monetary policy as policy rates have moved closer to their
effective lower bound. But it also has implications for the conduct of fiscal
policy as well as for the optimal deployment of macroprudential tools.
The link between low interest rates and fiscal policy in Denmark will be
the topic for the panel discussion later this morning.
As Governor of Danmarks Nationalbank, the causes and consequences of
very low interest rates is something that has been high on the agenda for
at least a decade. In July 2012 we were the first central bank to introduce
negative policy rates. And in early 2015 we reduced our key policy rate to
-0.75 per cent. This means that together with the Swiss National Bank, we
are the central bank that has operated with the lowest level of the key
policy rate.
While we have been at the forefront when it comes to low and negative
interest rates, we are clearly part of an international trend. Policy rates
are currently negative in Denmark, Switzerland, Japan and the euro area.
And in most other advanced economies, they are close to zero. This did
not happen overnight. As you can see from this chart, policy rates have
been trending downwards since the 1980s.
Chart 1: Policy rates have declined across the advanced economies
The secular decline in interest rates is no coincidence. It reflects key
underlying economic and financial developments. First, the underlying
equilibrium real interest rate, or r* for short, has declined. This is the real rate
of interest that balances savings and investments so that inflation
remains stable. This chart shows estimates of r* for Denmark, the United
States as well as a group of advanced economies.
Chart 2: Low policy rates reflect decline in equilibrium real rate of interest
UNDERSTANDING THE DECLINE IN R*.
The decline in r* reflects that from a global perspective, desired savings
have risen relative to desired investments.1 But as we cannot interact
with Mars, realised investment must equal realised savings at the global
level. This means that in equilibrium, interest rates have declined.
Changing demographics have been identified as a key factor behind the
decline in r*. In particular, an ageing population is found to have been
driving up desired savings, thereby pushing down equilibrium interest
rates.
Moreover, the decline in productivity growth that has been observed in
many advanced economies since the 1990s may have reduced the
incentive for firms to invest in new equipment. At the same time, slower
productivity growth and hence slower growth in earnings may have
contributed to higher household savings rates. If a household expects its
incomes to increase substantially it has less incentive to save for the future.
From that logic, weaker growth in incomes will tend to increase savings,
putting downward pressure on r*.
The distribution of income and wealth across individuals is also a
potential factor behind the decline in equilibrium interest rates.2 In a number of
countries, the distribution of wealth in particular has become more
uneven. As the wealthiest part of the population typically has a lower pro-
pensity to consume, this has contributed to an increase in global desired
savings and hence a decline in r*.
We observed a pronounced decline in estimates of r* in the immediate
aftermath of the financial crisis. This is likely to reflect that the financial
crisis led to a general reassessment of risks among firms and households
in many countries, prompting them to deleverage. With a more cautious
approach to savings and spending, r* must fall. This has been
corroborated by stricter financial regulation that was implemented in response to
the crisis.
The link between financial regulation and interest rates goes two ways.
While a more prudent approach to spending and savings may have
reduced equilibrium interest rates, an extended period of very low rates
may in itself call for tighter regulation. In particular, such an environment
may increase the risk of unsustainable increases in asset prices. This may
be the case if investors take on more risk to increase returns or if they
become overly optimistic about further increases in asset prices, thereby
fuelling an asset price bubble. This leaves an important role for
appropriately designed macroprudential measures.
INFLATION AND MONETARY POLICY
In addition to the decline in r*, very low policy rates in recent years also
reflect that central banks have tried to stimulate aggregate demand in
order to reach their inflation targets. In fact, inflation in many advanced
economies has been subdued for an extended period of time as
illustrated by the chart.
Chart 3: Extended period of subdued inflation following global financial
crisis
It is not the first time in history that real interest rates are negative across
a number of advanced economies. But whereas earlier episodes of
negative real rates have reflected temporary bouts of inflation, this time it has
coincided with highly subdued price pressures in many countries.
While the key priority of monetary policy used to be to avoid inflation
running too high, many central banks are currently struggling to avoid a
situation where inflation drifts too far below target and inflation
expectations risk becoming de-anchored. To that end, low policy rates have been
accompanied by a number of other measures such as quantitative easing
and forward guidance.
Danmarks Nationalbank sets policy rates with the sole objective of
keeping the Danish krone pegged to the euro. This means that we do not
consider developments in equilibrium interest rates or inflation when
making decisions on monetary policy. But the policy regime implies that
our policy rates closely follow those of the ECB. So, in that sense the
decline in our policy rates reflects the same factors that have driven down
interest rates in the euro area.
Significant deviations between Danish and euro area policy rates only
occur in situations with considerable pressure in foreign exchange markets.
In fact, the initial introduction of negative policy rates in 2012 reflected
substantial capital inflows amid the European sovereign debt crisis. And
the reduction of the policy rate to a record low of -0.75 per cent in early
2015 was necessitated by very strong capital inflows following the
decision of the Swiss National Bank to discontinue the ceiling on the Swiss
Franc and the subsequent announcement of a large scale asset purchase
programme by the ECB. But despite very low Danish monetary policy
rates, subdued consumer price inflation means that real interest rates in
Denmark are not lower than in a number of other countries.
THE IMPACT ON THE PENSION SECTOR
While the decline in interest rates reflects underlying economic
developments, the emergence of very low and even negative interest rates in
itself has important implications. In that respect the pension sector is of
particular interest as it makes decisions based on expected returns over
very long horizons. And in Denmark, assets in pension funds and other
retirement vehicles constitute more than 200 per cent of annual GDP,
which is very high in an international comparison.3
The chart illustrates how long-term yields have declined over the last two
decades, driving down the returns that pension funds can expect to earn
on their investments. The decline in expected returns coincided with a
substantial increase in longevity. Decreasing returns in conjunction with
rising longevity may appear as a dangerous cocktail for a pension fund.
But by shifting savers from schemes with a guaranteed minimum return
to market-based schemes, Danish pension funds have reduced the impact
of changes to returns and longevity on their financial position.
Chart 4: Long-term yields have declined
There is an ongoing debate about how pension savers respond to lower
expected returns. The intertemporal substitution effect suggests that as
return on savings declines, savers are encouraged to save less and spend
more. But there is also an income effect - lower returns on pension
savings make savers worse off in retirement.
In conventional macroeconomic models, the substitution effect
dominates the income effect - when the interest rate declines, savings fall. This
is also how I would expect interest rates to affect total private sector
savings.
It may be worth taking a closer look at the interaction between the two
effects when it comes to pension savings. Whereas total net financial
wealth of Danish households is negative, pension savings are obviously
positive financial wealth from the perspective of households. This is likely
to increase the importance of the income effect for this particular
component of savings. If households for example aim at achieving a specific
replacement ratio at the time of retirement, low real interest rates imply
that they have to save more. But as we are in unchartered territory with
negative nominal rates, more research in this area is vital.
THE TRANSMISSION VIA THE BANKING SECTOR
Many households and firms most directly feel the impact of low interest
rates via their bank. Lending as well as deposit rates have declined
alongside the reduction in policy rates as illustrated by the chart. For
lending rates, pass-through from policy rates has been more sluggish
than what we are used to. But we have not seen indications of a so-called
reversal rate, where negative policy rates become a drag on lending.4
Chart 5: Deposit rates have become negative
Now look at deposit rates. While our key policy rate first became
negative in July 2012, it was not until the beginning of 2015 that banks started
charging negative deposit rates to firms. Initially for large firms and
institutional investors, but increasingly to firms more generally.
For several years, household deposit rates appeared to be subject to a
zero lower bound. But in August of 2019, Jyske Bank announced as the
first Danish bank that it would charge negative rates on large household
deposits with effect from December of that year. Since 2019, most Danish
banks have introduced negative rates on deposits exceeding a certain
threshold as illustrated by this chart. Currently the threshold is typically
DKK 100,000, with deposits in excess hereof being remunerated at a rate
5
of -0.6 per cent. The banks have been reducing the threshold in steps as
they have been venturing into unchartered territory.
Chart 6: Most banks have introduced negative deposit rates for
households
THE RESPONSE OF FIRMS AND HOUSEHOLDS
In Danmarks Nationalbank, we have analysed how Danish firms and
households have responded to negative deposit rates. We find that when
a firm is exposed to negative deposit rates, it increases the likelihood
6
that the firm will move its deposits to another bank. Moreover, it
becomes more likely to repay debt. The effect of negative rates is not
limited to financial decisions. Firms that are charged negative deposit rates
also increase employment and investment in fixed capital compared to
other firms.
These findings suggest that the response of firms to changes in deposit
rates is non-linear at zero. This could reflect an 'awareness effect' - when
firms are exposed to negative deposit rates they may become more
aware of their economic situation. For example, firms with large bank
deposits are often approached by their bank when it introduces negative
deposit rates. Negative rates could also increase the risk appetite of
firms, explaining the observed pickup in employment and investment.
Somewhat similar to what we see for firms, there are indications that
households reduce deposits with banks that announce negative deposit
7
rates. In addition, they appear to increase their demand for investment
fund shares and switch their deposits to pool schemes.
As negative deposit rates for households are still a recent development,
we can only speculate on their wider implications. When new data
becomes available, it will be pertinent to study to which extent negative
deposit rates lead households to increase their spending - for example by
purchasing a new car or move to a more expensive home. If this is the
case, negative deposit rates may lead to more lending. But if households
instead simply reduce their deposits by paying back debt, lending could
decline.
CONCLUDING REMARKS
The transmission of negative policy rates is likely to differ across
countries for a number of reasons. For example, some countries have
legislation that restricts banks from imposing negative deposit rates.8
Nevertheless, the key lesson that I draw from our experience is that for the
financial sector, negative interest rates are increasingly becoming business as
usual. Even the key non-linearity associated with negative rates - the lack
of transmission to deposit rates - is fading.
For non-financial firms, preliminary evidence suggests that the
introduction of negative deposit rates had real effects on top of the standard
effects of a rate cut. This may also have been the case for households
although more evidence is needed in this area. But as firms and households
become more accustomed to paying interest on their deposits, these
effects may be attenuated.
Of course, there is a limit to how low rates can go. But we have seen that
negative policy rates are a viable policy tool in a world of low equilibrium
interest rates. Demographic factors suggest equilibrium interest rates are
likely to remain low for the foreseeable future. This suggests that the
topic for this conference could not have been more relevant.
Thank you for your attention!
DANMARKS
NATIONALBANK
ULTRA LOW INTEREST RATES FROM THE
PERSPECTIVE OF A CENTRAL BANKER
Governor Lars Rohde, Conference on 'The Long-run Outlook for Interest Rates', 1 September 2021
Policy rates have declined across the advanced economies
Per cent
25
United States, federal funds rate
20
United Kingdom, bank rate
15
Denmark, rate of interest on certificates of deposit
10
5
0
Euro Area, policy rate
-5
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
Note: Up until 1999, the Euro Area policy rate is represented by Deutsche Bundesbank's repo rate. From January 1999 till Oct ober 2008, the policy rate is represented by the ECB's main refinancing operations rate. From
November 2008, the policy rate is represented by the ECB's deposit facility.
Source: Macrobond.
Low policy rates reflect decline in equilibrium real rate of
interest
Per cent Per cent
5 6
4 4
Denmark
USA
3 2
2
0
Advanced Economies
1
-2
0
-4
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
Note: The natural real rate of interest is estimated with considerable uncertainty and the level differences between Denmark and the US/Advanced economies may reflect differences in estimation methods.
Source: Laubach and Williams (2003), "Measuring the Natural Rate of Interest," Review of Economics and Statistics, Holston, Laubach, and Williams (2017), "Measuring the Natural Rate of Interest: International Trends and
Determinants," Journal of International Economics, and Pedersen (2015), "The Danish natural real rate of interest and secular stagnation", Danmarks Nationalbank Working Papers.
Extended period of subdued consumer price inflation
following global financial crisis
Per cent
20
United Kingdom
15
10
Euro Area United States
5
0
Japan
-5
Danish long-term yields have declined
Per cent
10
9
8
7
30-year mortgage bond yield
6
5
4
3
10-year government bond yield
2
1
0
-1
Deposit rates have become negative in Danish banks
Per cent per annum
10
9
8
7
Lending rate, households
6
5
4
Lending rate, corporate sector
3
2
Deposit rate, households
1
0
Deposit rate, corporate sector
-1
-2
Most banks have introduced negative deposit rates for
households
Jyske Bank
Sydbank
Spar Nord Bank
Ringkjøbing Landbobank
Nordea
Den Jyske Sparekasse
Nykredit Bank
VestjyskBank
Jutlander Bank
Lån & Spar Bank
Danske Bank
Arbejdernes Landsbank
Handelsbanken
Sparekassen Kronjylland
Sparekassen Sjaelland-Fyn
Sparekassen Vendsyssel
Jul 19 Sep 19 Nov 19 Jan 20 Mar 20 May 20 Jul 20 Sep 20 Nov 20 Jan 21 Mar 21 May 21 Jul 21