Low interest rates and timid governments are trashing economic growth, warns OECD

Negative interest rates are harming growth - but it is hard to hike rates until growth takes off
Negative interest rates are harming growth - but it is hard to hike rates until growth takes off Credit: Ismo Pekkarinen/Rex Features 

Permanently low interest rates are ruining investments and savings, the Organisation for Economic Co-operation and Development (OECD) has warned, undermining long-term economic growth.

Low rates are designed as an emergency boost to crisis-stricken economies, but are harmful over long periods of time, the study said.

The only way out is for governments to reform stagnant economies, allowing bad companies to go bust, encouraging banks to write off loans to those failing companies, and encourage innovative firms to grow, it said.

Mario Draghi at the European Central Bank is keen on negative rates, and has long told governments to promote economic reforms
Mario Draghi at the European Central Bank is keen on negative rates, and has long told governments to promote economic reforms Credit: Michael Probst/AP

“Seven years of extremely easy monetary policy has not restored the investment and productivity growth needed to raise income per head, real wages, demand and growth,” said the OECD.

“This policy was originally designed to stabilise the financial system and support economic recovery, but somehow has slipped into trying to compensate for the absence of the other policies that are needed.”

These problems are in part coming to light because of the end of the upswing in commodities markets, as oil prices have dived along with other natural raw materials.

The OECD notes that investment in commodities and related sectors have driven much of the growth in the global economy, particularly in the emerging markets, in recent years.

As excess supply led to a decline in prices and brought that investment boom to an end, the economy suddenly looks in worse shape.

The drop in oil and other commodities prices is crushing one of the main drivers of investment growth in recent years
The drop in oil and other commodities prices is crushing one of the main drivers of investment growth in recent years Credit: WU HONG/EPA

Low interest rates will not help those emerging economies, the OECD said, nor the richer economies where lending is constrained by tighter banking rules imposed in the wake of the financial crisis.

The economists propose gradual moves to raise wages in the emerging markets, though this may depress investment further by pushing resources from firms to individual workers.

Richer countries need to take weak companies and banks off life support, and recognise that negative rates are harming even the healthy banks, the report said.

Those negative rates are also harming investors by creating “perverse incentives” and driving irrational behaviour in markets, the OECD warned.

“Investors have been herded into concentrated trades, many of which are illiquid, and recent volatility reflects periodic attempts to exit them – particularly when there is any hint of a withdrawal of the monetary policy ‘morphine’ to which they have become addicted,” the report said.

“Financial fragility means that central banks will embark upon the normalisation of interest rates only very slowly and the outlook for the next year or two in financial markets is one of choppiness about [a trend of modest returns], with persistent risks of extreme volatility.”

Until higher interest rates are imposed, investors will be concentrated in a “barbell” pattern of very low risk and very high risk investments, with little in between to finance the growth of companies that do not fit that pattern.

One scenario in which interest rates could rise is if inflation takes off, a situation that the OECD fears would be destructive.

It hopes that productivity will take off first instead, which requires the “creative destruction” of unproductive firms and the growth of innovative rivals – something that itself is stymied by low interest rates keeping those weak firms alive.

The OECD does not expect any of these vital reforms to emerge soon, leaving the world economy trapped in an environment of low interest rates and low productivity growth.

“It is difficult to convince governments that the only choice is incremental-but-persistent creative destruction when they are faced with unemployment – particularly in more rigid, less market-oriented economies,” the report said.

“Unfortunately structural reform on the scale required is unlikely in the near term. This means that creative destruction and a lift-off in rates is postponed. Central banks are most likely to continue with low interest rates and the quantitative easing approach.”

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