IMF Report Warns of Potential Era of Stagnation

Are low growth and low interest rates becoming the new normal?

A report from the International Monetary Fund (IMF) warns that the prolonged period of low interest rates and low growth that has characterized the global economy since the 2008 financial crisis may not end any time soon. That in turn could force major changes on pension funds, asset-management firms, and insurance companies.

“Advanced economies have experienced a prolonged episode of low interest rates and low growth since the global financial crisis,” according to the recently issued IMF Global Financial Stability Report. “The experience of Japan suggests that an imminent and permanent exit from a low-interest-rate environment need not be guaranteed.”

Many major economies are experiencing a combination of slow-moving structural shifts, the report notes, including an aging population and slower productivity growth. These “could conceivably generate a steady state of lower growth, and lower nominal and real interest rates in these countries.”

That would pose “a considerable challenge to financial institutions,” the report concluded. Over the long term, the business models of pension funds, banks, insurers, and the products offered by the financial sector would all have to change significantly.

“In such an environment, yield curves would likely flatten, lowering bank earnings and presenting long-lasting challenges for life insurers and defined benefit pension funds,” the report said.

The IMF offered a few suggestions for how policymakers and regulators can respond to changes in the financial landscape:

  • Make it easier to consolidate or liquidate failing banks, allowing the remaining firms to improve their profitability.
  • Limit incentives for banks to take on excessive financial risk.
  • Introduce frameworks that recognize the financial condition of insurance companies and pension funds by consistently evaluating assets and liabilities based on economic value.

Pension arrangements and the products and business models of life insurers would likely have to change significantly as well should low growth and low interest rates persist. Defined-benefit pension plans, for example, would have to reduce benefits. 

Life insurance companies also face threats to their profits and solvency, according to the report. Investments favored by life insurers, such as bonds, typically have shorter terms than their liabilities. As a result, insurers may have to reinvest maturing assets at lower yields while continuing to make high payouts on their policies, which could require them to raise more capital.

However, not everyone would be hurt by an extended period of stagnation. With defined benefit plans giving way to defined contribution plans, asset managers would see their market share increase as more people invest their retirement savings in stocks, bonds, and mutual funds. Asset managers could also siphon business away from life insurers as clients seek alternatives to the low yields provided by whole-life policies and other insurance products.\

Nothing is certain, of course, the IMF underscored. “The question is whether the post-crisis landscape represents a temporary departure from the pace of growth we’ve come to expect since World War II,” the report said, “or whether it’s the start of a new normal.”

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