Is this the dark side of ultra-low interest rates?

Insightful, counterintuitive cure, or good-money-after-bad, asset-bubble creating folly?

That seems to be the decision when it comes to the low interest rate, money supply expanding, liquidity promoting actions of many central banks.

Paul Krugman, amongst others, is seriously considered about the US (and the developed world together) entering into a Japan-style (or worse) liquidity trap where deflation takes hold and grinds what is left of the global economy to a halt and takes the last 4 jobs around with it. Private credit extension is sharply down, and consumption isn’t keeping pace with economic potential. Central banks need to plug this gap to return the economy to full employment. The rewards of economic growth will repay the costs incurred. Or so the argument goes.

The other side says that the hair of the dog won’t work. Low interest rates and easy money gave rise to a property (and other) asset bubble. The low interest rates were a policy response to earlier economic troubles and look where it got us. We need to take the pain now, impose austerity measures so that the economy can reset and return to health.

Both arguments need to be taken seriously. I generally favour the former, since the latter, while emotionally compelling, doesn’t seem to have as much theory and models to back it. It is interest that most of the supports of the “touch love” approach were the same ones who refused to admit the possibility of a property bubble and credit crisis just a few years back, which hurts their credibility.

But take a look at this article on the valuations of tech companies startups. It suggests that money is so cheap, and yield is so hard to find, that investors will throw their money at anything. Worryingly like a bubble.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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