LSE has announced a formal partnership with Swiss Re, one of the world’s largest reinsurers, to support an 18-month research programme on monetary policy and long-term investment.
The project is being led by Simeon Djankov, Executive Director of LSE’s Financial Markets Group, who is the former Deputy Prime Minister and Minister of Finance of Bulgaria. Ricardo Reis, A W Phillips Professor of Economics at LSE, is contributing to the project as a researcher. Jerome Haegeli, Swiss Re's Head of Investment Strategy at Group Asset Management is collaborating on the project with the aim to support a resilient financial market system.
It will examine two key questions. The first concerns the structure of central bank balance sheets in the future and the corresponding implications regarding their contribution to a well-functioning financial market. The structure of central bank balance sheet has changed substantially since the Global Financial Crisis, both in terms of the composition and the size of assets and liabilities. During the crisis, many major central banks expanded their asset holdings in efforts to supply monetary accommodation and support economic activity. Some central banks continue in this direction. Looking ahead, population trends and low levels of productivity growth are raising questions as to whether the equilibrium, or natural, real interest rate is lower. In a persistently low interest rate environment, central banks may turn more frequently to their balance sheet as an instrument of policy, raising questions both about the type of assets to hold and structure of liabilities.
The second will research the effect of loose monetary policy on structural reforms across Europe. The Eurozone crisis has shown significant vulnerabilities in the European social model. Europe is home to only 8% of the world's population, yet it produces 50% of all social payments (public pensions, healthcare benefits, maternity leave and associated benefits, public education) globally. These social benefits come at a large cost, typically covered by high taxation and chronic budget deficits. The latter have increased public debt in some Southern and Western European countries to dangerously high levels, even prior to the Eurozone crisis. The resulting fiscal tightening has gone along with pursuing structural reforms in public finances and social sectors across Europe. In 2010-2012, for example, two-thirds of European Union members have managed at least one significant structural reform. Since then, the increasingly loose monetary policy of the ECB has slowed down progress. In some cases, for example Italy, previously-initiated reforms were aborted.
The loose monetary policy has allowed government to borrow at essentially no cost, reducing their incentive to modernise the social sectors. There are some differences across Europe, especially among Eurozone and non-Eurozone countries. These differences can be exploited to conduct comparative analysis on the effects of loose monetary policy on structural reforms.
A financial markets roundtable discussion took place at LSE on 14 November, at which preliminary results from the two research themes were presented.
Simeon Djankov commented: “The preliminary research clearly shows that governments opt for the easy path out when offered a choice between structural reforms and cheap additional debt. This result holds both in advanced and in developing economies. Europe after 2012 is a striking example of how loose monetary policy can slow down reforms”.
Ricardo Reis commented: “With central banks' current large balance sheets, monetary policy decisions now have implications for financial markets through a host of varied and novel channels; exploring them is an exciting research agenda”.
Jerome Haegeli said: "Central banks' dominant role in financial markets is not sustainable. The costs are outweighing the benefits. Low interest rates result in a “tax” on savers and long-term investors alike. To increase financial market resilience, private capital markets should be strengthened. The allocation of private sector's risk capital is distorted and not put to best use for financing the real economy."
For more information
Liz Bunting, FMG Centre Manager, firstname.lastname@example.org or 0207 955 6206
Joanna Bale, LSE media relations office, email@example.com or 07831 609679
Carolyn Pike, Swiss Re media relations, firstname.lastname@example.org or +41 79 548 6392
The Big Ease and What's Next?
14 November 2016