Friday, November 29, 2013

29/11/2013: McKinsey estimates of QE effects on economies

Recent paper by McKinsey Global Institute, published November 2013 and titled "QE and ultra-low interest rates: Distributional effects and risks" looked at the effects of exceptional monetary policy measures implemented by the central banks in the US, the UK, Japan and the euro area since 2007.

"More than five years [since the beginning of the crisis] …central banks are still using conventional monetary tools to cut short-term interest rates to near zero and, in tandem, are deploying unconventional tools to provide liquidity and credit market facilities to banks, undertaking large-scale asset purchases—or quantitative easing (QE)—and attempting to influence market expectations by signaling future policy through forward guidance. These measures, along with a lack of demand for credit given the global recession, have contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years."

The "ultra-low interest rates have produced significant distributional effects if we focus exclusively on the impact on interest income and interest expense." as the result:

McKinsey's core findings include:

  • ƒ"Between 2007 and 2012, ultra-low interest rates produced large distributional effects on different sectors in advanced economies through changes in interest income and ...expense."
  • "By the end of 2012, governments in the US, the UK, and the Eurozone had collectively benefited by $1.6 trillion, through both reduced debt service costs and increased profits remitted from central banks."
  • "Meanwhile, households in these countries together lost $630 billion in net interest income, with variations in the impact among demographic groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income."
  • "Non-financial corporations across these countries benefited by $710 billion through lower debt service costs."
It is worth noting that the McKinsey study does not account for the effects of reduced unemployment and shallower recessions that were attributed to the deployment of the monetary policies. Neither does the study account for the effects of higher taxation levied by the Governments on households.

Banking sector effects identified in the study are:

  • "The era of ultra-low interest rates has eroded the profitability of banks in the Eurozone. Effective net interest margins for Eurozone banks have declined significantly, and their cumulative loss of net interest income totaled $230 billion between 2007 and 2012."
  • "...Banks in the US have experienced an increase in effective net interest margins as interest paid on deposits and other liabilities has declined more than interest received on loans and other assets. From 2007 to 2012, the net interest income of US banks increased cumulatively by $150 billion."
  • "Over this period, therefore, there has been a divergence in the competitive positions of US and European banks."
  • "The experience of UK banks falls between these two extremes."

Financial companies and assets:

  • "Life insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates. Those insurers that offer customers guaranteed-rate products are finding that government bond yields are below the rates being paid to customers."
  • Obviously, not a word about the vast financial repression sweeping across the financial sector, especially in the euro area, which is seeing assets seized for 'tax raising' etc.
  • But a stern warning: "If the low interest-rate environment were to continue for several more years, many of these insurers would find their survival threatened."
  • And, not stated but on everyone's mind: if the low interest-rate environment were to come to an end, wholesale bankruptcy of household and corporate financial balance sheets will do miracles to the economies too...
  • Per McKinsey: "The impact of ultra-low rate monetary policies on financial asset prices is ambiguous. Bond prices rise as interest rates decline, and, between 2007 and 2012, the value of sovereign and corporate bonds in the United States, the United Kingdom, and the Eurozone increased by $16 trillion."
  • "But we found little conclusive evidence that ultra-low interest rates have boosted equity markets. Although announcements about changes to ultra-low rate policies do spark short-term market movements in equity prices, these movements do not persist in the long term. Moreover, there is little evidence of a large-scale shift into equities as part of a search for yield. Price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages."


  • "Ultra-low interest rates are likely to have bolstered house prices, although the impact in the United States has been dampened by structural factors in the market. At the end of 2012, house prices may have been as much as 15 percent higher in the United States and the United Kingdom than they otherwise would have been without ultra-low interest rates, as these rates reduce the cost of borrowing."
  • "If one accepts that house prices and bond prices are higher today than they otherwise would have been as a result of ultra-low interest rates, the increase in household wealth and possible additional consumption it has enabled would far outweigh the income lost to households. However, while the net interest income effect is a tangible influence on household cash flows, additional consumption that comes from rising wealth is less certain, particularly since asset prices remain below their peak in most markets. It is also difficult today for households to borrow against the increase in wealth that came through rising asset prices."
Summary of the effects:

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