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Artificially low interest rates: Eye on 3 consequences

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As many Americans prepare for retirement, more people are becoming concerned with how negative interest rates will affect their savings.

Effect of low rates

Negative rates may create instability and lead to unexpected financial disruption. Interest rates measure the preference of economic agents for the present rather than the future.

We know the reason behind the current ultra-low rates: extremely accommodative monetary policies worldwide. This quantitative easing creates an artificial imbalance between supply and demand and the equilibrium price is an artificial price.

Related: Annuities: Your go-to financial vehicle in a low-interest-rate environment

Former U.S. Secretary of the Treasury Larry Summers proposes a convincing approach, “Secular Stagnation,” wherein the real equilibrium interest rate would be negative; and the accommodating policies of central banks would only adjust the curve of rates to this negative equilibrium rate.

But without massive debt purchases through money creation by central banks, the rates would obviously be higher; and, therefore, the current situation is artificial. The positive impact of this money creation on the economy is yet to be seen. The only clear effect is the creation of financial bubbles within a number of asset classes.

I draw three consequences from this situation:

Result #1: The current state of interest rates is very unstable. Endlessly solving growth and debt problems through money creation is an illusion.

There would need to be cooperative play worldwide to find a solution. This would include structural reforms, as well as the acceptance of lower growth and lower living standards, which means we likely won’t see this resolved for quite some time.

Related: Insurance regulators respond to ongoing low interest rates

The overcapacity problem generated by a low interest rate environment will need to be adjusted, writes AXA’s François Robinet. (Photo: Thinkstock)

Result #2: Negative interest rates lead to different savings behaviors, especially if the situation is prolonged. The need to save is increasing, along with increased life expectancy and the disappearance of pensions.

Related: Jamie Dimon says it’s time for Fed to raise interest rates

People will seek positive performance despite negative rates, which may lead to taking on more risk. This can end poorly without proper guidance and a thorough understanding of the market.

However, asset valuation is also evolving as younger generations factor in social responsibility beyond just monetary performance. The industry will have to respond to individual customer needs while offering upside potential and appropriate risk management.

Result #3: The savings management industry will have to reform and reinvent itself in a fundamental manner. First, the overcapacity problem generated by this rate environment will need to be adjusted.

Second, the adjustment will entail new products that redefine risk/return in a negative interest rate environment. New business models and ways of looking at banking, insurance and asset management will originate, at least in part, from non-traditional players. This opens up the playing field to fintechs that can use technology and innovation to form part of the solution.

Low rates for the long-term

The dramatic rate cuts around the world are likely here to stay because we don’t have a simple solution. We must all — as savers, asset managers, product distributors, policy makers and innovators — take stock and recognize the importance of this paradigm shift.

François Robinet is CEO of AXA Life Invest and managing partner of AXA Strategic Ventures. Read his full bio here.

See also:

MetLife CEO on interest rates, Brexit and restructuring

Life insurance in a low interest rate environment

Insurance regulators respond to ongoing low interest rates

The Titanic risks of the retirement system