A prolonged period of low interest rates in Europe: Unintended consequences

Abstract

We examine the potential adverse effects of a prolonged period of low interest rates on financial stability from multiple perspectives. First, we provide a unique comparison of natural rates of interest estimated using two approaches—with and without financial factors—for six large European countries inside and outside the euro area. Second, we provide a comprehensive review of the empirical literature, allowing us to identify and categorize financial vulnerabilities, which may be created and fueled by low interest rates. Third, we discuss a situation in which a prolonged period of low interest rates may lead to a point of no return by contributing to higher indebtedness, overvalued asset prices and underpriced risks, resource and credit misallocation, and lower productivity. With respect to all of that, we offer a few monetary policy considerations. Specifically, we suggest that (i) monetary policy should act symmetrically over the medium to long term, (ii) both the short‐term and long‐term costs and benefits of pursuing accommodative or restrictive monetary policy should be accounted for, and (iii) monetary and macroprudential policies need to be coordinated, and their interactions should be accounted for in order to find the best policy mix for the economy.

Macroeconomic Determinants of Insurance Companies’ Financial Stability: The Case of the Czech Republic

“…Although the interest rate was not statistically significant determinant of insurers" financial stability, it is necessary to state that the analysed period was connected with a low interest rate in the Czech Republic. Malovaná et al (2020) suggested that low interest rates may undermine the solvency of insurance companies and or ESRB (2015) added that the scenario of a prolonged low-interest rate environment in conjunction with a drop-in asset prices is considered to be one of the most destabilizing events for European life insurers and the real economy as well. However, since 2020 in the Czech Republic, the interest rate has increase, the supervisory authorities as well as the management of insurers could focus the attention on the insurance stability.…”

“…However, since 2020 in the Czech Republic, the interest rate has increase, the supervisory authorities as well as the management of insurers could focus the attention on the insurance stability. As Malovaná et al (2020) pointed, if a period of low interest rates ends with a sudden rise in rates, insurance policyholders may withdraw their funds ahead of maturity (surrender). This will become a source of liquidity vulnerability for insurance companies (CGFS 2018).…”

Bank capital, lending, and regulation: A meta‐analysis

“…Statistically, this can be driven by the fact that the period of low interest rates coincides with substantially increased macroprudential policy activity (Alam et al., 2019). Record low interest rates have depressed bank profitability and may have encouraged risk taking and hence increase the probability of default (for a literature review, see Malovaná et al., 2022). The associated risks were aimed to be contained by increased engagement of macroprudential policy.…”

The Effect of Structural Risks on Financial Downturns

“…What is particularly interesting is the effect of the low interest rates seen before 2008 on the relationship between credit risk materialization and structural risks. Based on the emerging literature on the topic, we assume that low interest rates may amplify the negative impact of structural risks on credit risk (Bikker & Vervliet 2018, Malovana et al 2020, ESRB 2021.…”