The Bankwatch

Tracking the consumer evolution of financial services

The real reason for maintaining artificially low interest rates – and what banks can do

A remarkable (if hard to read) piece from Martin Wolf highlights the underlying reason that artificially low interest rates are essential to prevent “uncontrolled collapse .. mass bankruptcy”

Why we have to live with low interest rates | – Martin Wolf

The deepest question is whether current policy risks generating huge disturbances in future. As both Ms Altmann and Mr Smithers note, encouraging spending by raising asset prices evidently risks creating another round of what Austrian economists label “malinvestment”. Credit may also surge, once more, generating another round of irresponsible behaviour in the financial sector and ultimately another wave of financial and economic crises, quite possibly in emerging economies. It would be foolish to ignore those evident risks.

Yet it would be just as foolish to ignore the just as pressing present dangers. Today, the UK and a number of other economies, including the US, are both excessively leveraged and have weak financial sectors. The low interest rate policy is designed to prevent an uncontrolled collapse of this mountain of leverage into mass bankruptcy and, instead, allow debt to be paid down and the financial system to return to health more gradually.

Thus, we have to choose between low interest rates on current assets or better returns on what would soon be shrunken assets: with higher rates, house prices would fall further, unemployment would rise, more loans would default and banks would fall back into difficulties. Ms Altmann argues that the bubble economy was partly an illusion. So, then, must be a big part of the financial claims on which savers now depend.

The question becomes whether this approach will prevent such events or will merely introduce delay.

Relevance to Bankwatch:

Martin is as close to the ‘powers that be’ as anyone.  The fact that there is a low interest rate policy indicates that it is temporary in nature with en eventual end.  This is where banks should come in.  When that end occurs obviously interest costs will rise and there will be people in a problem.  Banks if they were smart and thinking about their customers and also their own future bad debts, should be migrating loan products away from credit cards and lines of credit towards amortised loans.  This would take advantage of the low interest environment to pay down debt.  The alternative is to require customers to pay down debt when rates are higher – that hardly sounds like a smart alternative. 

Written by Colin Henderson

December 10, 2010 at 23:44

One Response

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  1. This is very confusing


    December 20, 2010 at 20:58

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