Real Interest Rates, Imbalances and

The Curse of Regional Safe Asset Providers

Pierre-Olivier Gourinchas1 Helene Rey2

1UC Berkeley & NBER & CEPR

2London Business School & NBER & CEPR

June 2016

European Central Bank Forum on Central Banking

1 / 23

The Questions We Address:

I Why are global real interest rates so low and for how long?(Secular Stagnation [Hansen (1939), Summers (2013)], Savings Glut[Bernanke (2005)])

I In this low growth, low real rates environment, what can we sayabout global imbalances?

I What specific issues are facing ‘regional safe asset providers’ such asSwitzerland or core EMU?

2 / 23

Global Interest Rates (10-year)

-2

0

2

4

6

8

10

12

14

16

18

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

percent

U.S. Germany U.K. Japan

Financial Crisis Eurozone Crisis

3 / 23

‘Historical’ U.S. Real Rates, 1870-2011

0

10,000

20,000

30,000

40,000

0

50,000

100,000

150,000

200,000

250,000

1875 1900 1925 1950 1975 2000

real consumption per capita real wealth per capita

.14

.16

.18

.20

.22

.24

.26

.28

1875 1900 1925 1950 1975 2000

consumption/wealth ratio

-.15

-.10

-.05

.00

.05

.10

.15

.20

1875 1900 1925 1950 1975 2000

short term real interest rate (percent)

The figure reports the annualized realized real 3-month interest rate for the U.S. since 1870.

Source: Jorda et al (2016).

4 / 23

An Empirical Framework

I Look at the ratio of consumption (C ) to wealth (W ) over a longperiod of time.

I Accounting identity (budget constraint) implies that ratio C/W isbelow average when:

I Consumption is expected to grow faster in the future, orI Wealth is expected to grow more slowly in the future: low future

return on wealth

I The return on wealth is the risk-free rate r f plus an excess return rp.

I Formally:

ln(Ct/Wt) =∑∞

s ρs r ft+s +∑∞

s ρs rpwt+s −∑∞

s ρsgCt+s

= cw rft + cw rp

t + cwct

5 / 23

‘Global’ Consumption/Wealth Ratio, 1920-20110

5,000

10,000

15,000

20,000

25,000

30,000

0

40,000

80,000

120,000

160,000

200,000

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

real consumption per capita real wealth per capita

.14

.16

.18

.20

.22

.24

.26

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

consumption/wealth ratio

-.12

-.08

-.04

.00

.04

.08

.12

.16

.20

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

short term real interest rate (percent)

The figure reports the ratio of aggregate annual private consumption expenditures to total private

wealth (land, housing, financial assets) for the U.S., U.K., Germany and France.

6 / 23

An Empirical Framework

I Look at the ratio of consumption (C ) to wealth (W ) over a longperiod of time.

I Accounting identity (budget constraint) implies that ratio C/W isbelow average when:

I Consumption is expected to grow faster in the future, orI Wealth is expected to grow more slowly in the future: low future

return on wealth

I The return on wealth is the risk-free rate r f plus an excess return rp.

I Formally:

ln(Ct/Wt) =∑∞

s ρs r ft+s +∑∞

s ρs rpwt+s −∑∞

s ρsgCt+s

= cw rft + cw rp

t + cwct

7 / 23

Decomposing the Global Consumption/Wealth Ratio

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.Predicted

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

LCWM

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Predicted

The figure decomposes the fluctuations in ln(C/W ) around its mean into a risk-free component

(cw rf ), an excess return component (cw rp) and a consumption growth component (cwc).

8 / 23

Decomposing the Global Consumption/Wealth Ratio

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.Predicted

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

LCWM

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Predicted

The figure decomposes ln(C/W ) into a risk-free component (cw rf ), an excess return component

(cw rp) and a consumption growth component (cwc).

9 / 23

Decomposing the Global Consumption/Wealth Ratio

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.Predicted

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

LCWM

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Predicted

The figure decomposes ln(C/W ) into a risk-free component (cw rf ), an excess return component

(cw rp) and a consumption growth component (cwc).

10 / 23

Decomposing the Global Consumption/Wealth Ratio

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.Predicted

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

LCWM

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Predicted

The figure decomposes ln(C/W ) into a risk-free component (cw rf ), an excess return component

(cw rp) and a consumption growth component (cwc).

11 / 23

Decomposing the Global Consumption/Wealth Ratio

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.Predicted

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

LCWM

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Risk free comp.Risk premium comp. Consumption comp.

-.4

-.3

-.2

-.1

.0

.1

.2

.3

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

ln(c/w) Predicted

The figure decomposes ln(C/W ) into a risk-free component (cw rf ), an excess return component

(cw rp) and a consumption growth component (cwc).

12 / 23

Predicting Global Real Risk-free Rates

-.12

-.08

-.04

.00

.04

.08

.12

.16

.20

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

1-year ahead

-.10

-.05

.00

.05

.10

.15

.20

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

2-years ahead

-.06

-.04

-.02

.00

.02

.04

.06

.08

.10

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

5-years ahead

-.12

-.08

-.04

.00

.04

.08

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

actualfitted

10-years ahead

The figure forecasts the 10-year average future short risk-free rate using ln(C/W ). Graph includes2 standard deviation bands.

2015-2025 forecast: −2%

13 / 23

Low Real Rates: Why and How long?

I Empirical evidence favors global financial boom/bust cycle(Miranda-Agrippino & Rey (2015))

I Deleveraging post crisis: increased demand for ‘safe’ assets

I Little evidence for technological slowdown or demography factors (?)

I How long? Well into next decade!

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Global Imbalances

I Receded but did not disappear

I Salient feature: all eurozone members are in surplus.

I Become ‘malign’ at the Zero Lower Bound: excess saving push theworld into a global recession(Caballero, Farhi & Gourinchas (2016))

I Potential for currency wars: rotating depressed world demand, butnot stimulating world economy

15 / 23

Global Imbalances

-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

%OFWORLDGDP

U.S. Eurozone 12 Japan OilProducers EmergingAsiaex-China China Restoftheworld

Financial CrisisAsian Crisis Eurozone Crisis

Figure: Current Account, percent of World GDP

Source: WEO April 2016.16 / 23

Eurozone Imbalances

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

1993 1996 1999 2002 2005 2008 2011 2014 2017

%ofEurozon

eOutpu

t

Germany Ireland Greece Portugal Italy

Spain France Netherlands Others Euro12

Figure: Current Account Balances, percent of Eurozone GDP

Source: WEO. April 201617 / 23

Global Imbalances

I Receded but did not disappear

I Salient feature: all eurozone members are in surplus.

I Become ‘malign’ at the Zero Lower Bound: excess saving push theworld into a global recession(Caballero, Farhi & Gourinchas (2016))

I Potential for currency wars: rotating depressed world demand, butnot stimulating world economy

18 / 23

The Curse of (Regional) Safe Asset Providers

I If safe assets are scarce, their price must be high (low risk-free rates)

I Suppliers of safe assets:I have lower funding costs (‘exorbitant privilege’)I must face increased external exposure (‘exorbitant duty’)

I How risky? U.S. losses of 23% of GDP between 2008 and 2015.Potentially larger losses for Switzerland.

I Trade-off: tomorrow’s exposure vs. today’s currency appreciation.(Triffin (1960))

I But: worse trade-off the smaller is the safe asset provider:Curse of the Regional Safe Asset Provider

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‘Net Risky’ and ‘Net Safe’, United States, 1952-2015

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

NetRiskyandNetSaferelativetoGDPUnitedStates,1952:1-2015:4

Net Risky/GDP Net Safe/GDP

Net Risky = Net Portfolio Equity and Direct Investment; Net Safe = Net Portfolio Debt and Other

Assets. Percent of U.S. GDP

20 / 23

The Curse of Regional Safe Asset Providers

The figure illustrates how the trade-off between net external exposure and real appreciation varies

with size. A large safe asset provider chooses point A. A small safe asset provider chooses point B.

If the currency is fixed, the country is at point C . Results based on Gourinchas, Rey & Govillot

(2010).

21 / 23

Case Studies: Switzerland & core EMU

I Switzerland: illustrates the trade-off: point C , then point B

I Core EMU:I core EMU banks intermediated capital flows from EMU savers

and rest of the world to EMU periphery

I because of the common currency, could not limit their exposureby appreciating the currency (point C )

I cross border loans, not portfolio: protracted resolution process& only mild losses. Multiple rounds of deleveraging lossespushed onto periphery EMU

I forces EZ into external surpluses, contributing to excesssavings, safe asset scarcity and global ZLB.

I With an exposure structure similar to the U.S., would haveexpected valuation losses for core EMU close to 40% of itsGDP!

I curse of core EMU may be a curse for rest of EZ and rest of theworld too!

22 / 23

Conclusion

I Global real interest rates will remain low for long

I Why? Evidence points to deleveraging forces post financial crisis.Demand for safe liquid stores of value.

I Global Imbalances mutates at the ZLB (‘malign’): greater scope forspillovers and currency wars

I Regional Safe Asset Providers face unpleasant trade-off: Curse ofthe Regional Safe Asset Provider

I Excessive Eurozone surpluses contribute to global ZLB.

I Solutions: (a) delinking safe asset supply within EZ from singlecountry; (b) orderly and speedy loss-taking mechanism;(c) CapitalMarkets union.

23 / 23