24 Feb 2020
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Since the global financial crisis, the US has experienced the longest run of economic growth in history over a colossal 126 months. Despite the prolonged stretch, the average annual GDP growth is shallow at 2.3% when compared to the 80’s where 4.3% was reached overall followed by 3.6% in the 90’s.
You might think that prolonged economic growth represents financial utopia but there are issues that can stem from such a long period of development. Recessions are generally considered to be damaging but they are part and parcel of normal economic cycles as they deliver ‘creative destruction’. They clear out old economy companies that are only just surviving allowing the more resilient business models to take market share, creating an enriched economic backdrop where entrepreneurship thrives and new businesses flourish.
At the end of the last financial crisis, to stave off financial collapse, world interest rates fell as low as 0%. The government pumped liquidity into the system in the form of Quantitative Easing (QE). Quantitative easing is an unconventional monetary policy where a central bank buys securities from the market to increase the money supply and encourage lending and investment. When short-term interest rates are at or approaching zero, normal open market operations that target interest rates are no longer effective, so central banks can target specified amounts of assets to purchase.
In a financial crisis, QE can help to stimulate the economy, but this strategy seems to gradually weaken in its effect on the real economy each time it’s rolled out. In part, this can be put down to a shift in behaviour where people are saving, paying off personal debts or buying equities instead of spending. QE has also had a noticeable effect on the stock market where the weight of new money invested has caused a substantial rise in asset prices.
In normal economic conditions, interest rates will be higher, moderating inflation, providing bond investors with reasonable returns and adequately compensating savers. Another benefit of higher rates is that if the economy falters, there is scope to reduce interest rates to stimulate the economy. However, policy makers are unable to raise interest rates significantly as this would inflict losses on central bank bond holdings and choke off the already low levels of growth.
After the depression in the US in the 30’s, QE was introduced and lasted for 15 years. Japan experienced a big crash in the 80’s and various tactics were used to stimulate the economy. The result is that they have had low growth and interest rates spanning the last 30 years. The use of QE in Japan and the US has been replicated in the UK, but the question is, will this have the same effect and cause Japanification of the UK?
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This information is for UK Professional Advisers only and should not be given to retail clients.The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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