The Safe Asset Scarcity Conundrum

By Professor Jeff Borland
Department of Economics, University of Melbourne

Low interest rates are here to stay, according to one of the world’s leading macroeconomists. Speaking at this year’s Finch lecture at the University of Melbourne, Professor Pierre-Olivier Gourinchas from UC Berkeley, forecast that the real rate of interest on risk-free assets would remain at zero or negative levels through to at least the early 2020s.

In the aftermath of the Global Financial Crisis, the real rate of interest on risk-free assets in the United States fell by 2 percentage points, and has remained at around zero since that time. Explaining the fall, and assessing its consequences, were the main topics addressed by Professor Gourinchas.

Commentators have identified several potential explanations for the low rate of interest. Slow productivity growth, the ageing population, a savings glut, deleveraging and safe asset scarcity are some of the main suggested culprits. With population ageing, for example, a growing proportion of households are being headed by workers near the end of their careers for whom savings are at a peak; and hence there is a rising level of aggregate savings in the economy that lowers the rate of interest.

Professor Gourinchas chose to focus on two potential explanations where he has made important recent contributions – deleveraging and safe asset scarcity.

Deleveraging happens where households and businesses choose to pay off debt rather than to consume or invest. Paying off debt implies a lower demand for borrowing, and therefore a lower rate of interest. Professor Gourinchas described how the global proportion of wealth being consumed at present is at an historically low level. He interprets this development as evidence of deleveraging and an expectation by consumers that the risk free rate of interest will remain low in future years.

Professor Gourinchas
Professor Gourinchas presenting at the 2017 Finch Lecture

The other explanation investigated by Professor Gourinchas is that safe assets have become more scarce, which accounts for the low rate of interest paid on those assets. The increase in scarcity, he argues, has been driven both by a decrease in the supply of safe assets (especially central government debt), and by an increase in demand for safe assets following the Global Financial Crisis. A rising equity risk premium, for example, supports the hypothesis that investors have sought to move away towards safe assets.

At the end of his lecture Professor Gourinchas turned to the consequences of living with a low rate of interest on risk free assets. A major consequence of the low interest rate is the limits it imposes on the ability of central banks to stimulate economic activity through monetary policy – since the real interest rate is already at a floor and cannot be lowered. Without this capacity to stimulate demand, global economic activity will remain below its potential level. The danger, according to Professor Gourinchas, is that countries will then begin to ‘compete’ for the available jobs through currency depreciation and protection against imports – policies which ultimately are likely to be self-defeating.

How to deal with this problem? Professor Gourinchas suggested that there is no easy solution – but some policies which might improve the situation. Examples that could be considered are getting the issuers of safe assets, such as the Australian government, to increase the supply of those assets; or relaxing regulations on the extent to which banks in the major economies are required to hold their reserves in safe assets.

But any policy is likely to bring difficulties. Countries which increase the supply of safe assets are likely to experience currency appreciation with the cost of making their economy less competitive in international trade. Changes to regulations for the composition of bank reserves might face political opposition while the Global Financial Crisis is still fresh in memory.

David Finch was an alumnus of the University of Melbourne, graduating with joint honours degrees in commerce and arts in 1944 and received a PhD from the London School of Economics. He was appointed to the newly established International Monetary Fund (IMF), where he held the position of Councillor and Director of the Exchange and Trade section of the IMF. He was awarded an Honorary Doctor of Commerce by the University of Melbourne, two years before his death, in 2000.

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