Daniel Gros writes:\u00a0 The developed world seems to be moving toward a long-term zero-interest-rate environment. Though the United States, the United Kingdom, Japan, and the eurozone have kept central-bank policy rates at zero for several years already, the perception that this was a temporary aberration meant that medium- to long-term rates remained substantial. But this may be changing, especially in the eurozone.<\/p>\n
Strictly speaking, zero rates are observed only for nominal, medium-term debt that is perceived to be riskless. But, throughout the eurozone, rates are close to zero \u2013 and negative for a substantial share of government debt \u2013 and are expected to remain low for quite some time.<\/p>\n
In Germany, for example, interest rates on public debt up to five years will be negative, and only slightly positive beyond that, producing a weighted average of zero. Clearly, Japan\u2019s near-zero interest-rate environment is no longer unique.<\/p>\n
To be sure, the European Central Bank\u2019s large-scale bond-buying program could be suppressing interest rates temporarily, and, once the purchases are halted next year, they will rise again. But investors do not seem to think so.<\/p>\n
The eurozone seems stuck with near-zero rates at increasingly long maturities. What does this actually mean for its investors and debtors?<\/p>\n
Japanese savers have been benefiting from this phenomenon for more than a decade, reaping higher real returns than their counterparts in the US, even though Japan\u2019s near-zero nominal interest rates are much lower than America\u2019s.<\/p>\n
Nonetheless, nominal rates are negligible, they flatter profit statements, while balance-sheet problems slowly accumulate.<\/p>\n
Given that balance-sheet accounting is conducted according to a curious mix of nominal and market values, it can be opaque and easy to manipulate. If prices \u2013 and thus average debt-service capacity \u2013 fall, the real burden of the debt increases.<\/p>\n
In an environment of zero or near-zero interest rates, creditors have an incentive to \u201cextend and pretend\u201d \u2013 that is, roll over their maturing debt, so that they can keep their problems hidden for longer.<\/p>\n
Japan\u2019s experience illustrates this phenomenon perfectly. At more than 200% of GDP, the government\u2019s mountain of debt seems unconquerable. But that debt costs only 1-2% of GDP to service, allowing Japan to remain solvent. Likewise, Greece can now manage its public-debt burden, which stands at about 175% of GDP, thanks to the ultra-low interest rates and long maturities (longer than those on Japan\u2019s debt) granted by its European partners.<\/p>\n
In short, with low enough interest rates, any debt-to-GDP ratio is manageable. That is why, in the current interest-rate environment, the Maastricht Treaty\u2019s requirement limiting public debt to 60% of GDP is meaningless.<\/p>\n
In fact, near-zero interest rates undermine the very notion of a \u201cdebt overhang\u201d in countries like Greece, Ireland, Portugal, and Spain. While these countries did accumulate a huge volume of debt during the credit boom that went bust in 2008, the cost of debt service is now too low to have the impact \u2013 reducing incomes, preventing a return to growth, and generating uncertainty among investors \u2013 that one would normally expect. Today, these countries can simply refinance their obligations at longer maturities.<\/p>\n
<\/p>\n","protected":false},"excerpt":{"rendered":" Daniel Gros writes:\u00a0 The developed world seems to be moving toward a long-term zero-interest-rate environment. Though the United States, the United Kingdom, Japan, and the eurozone have kept central-bank policy rates at zero for several years already, the perception that … Continue reading ![\"Cost-Free](\"http:\/\/www.w-t-w.org\/en\/wp-content\/uploads\/2015\/04\/Cost-Free-Money.jpg\")
<\/a><\/p>\n