The Price of Time: The Real Story of Interest

Bad debts weren’t the only challenge facing banks in the post-crisis years. Banks make money by lending out deposits for a profit – borrowing short and lending long, as the saying goes. But ultra-low interest rates eroded the banks’ ‘net interest margin’, damaging their profitability and making them reluctant to initiate new loans.15 And while extr

By 2014, five years after the end of the Great Recession, US productivity growth trailed at half its historic average.2 Under Ben Bernanke, America’s central bank wasn’t standing pat, as it had done in the early 1930s. In fact, the Fed’s balance sheet expanded by more than the total dollar increase in US national income.3 Across the Atlantic, the s

The world economy seemed to be following a rule laid down by Chicago economist Victor Zarnowitz, namely that ‘deep recessions are almost always followed by steep recoveries’.

We have seen how the Fed’s pursuit of price stabilization in the 1920s contributed to that era’s credit boom and speculative excesses. Fixing a specific target to the same policy only exacerbates matters. It has long been recognized that managing institutions by reference to a fixed quantitative indicator has its limitations.fn11 Quantitative targe

Not only did the major central banks in the developed world now have a target, but they all coalesced around the same number: 2 per cent acquired talismanic significance – what Governor Kuroda called a ‘global standard’.42 The number was written into the ECB’s constitution. It was constantly invoked by central bankers, as if repetition would help t

Why were the credit systems of so many different countries, from Australia to Iceland, so vulnerable at the time? The unifying factor appears to be the low-interest rate policy of the Federal Reserve at the turn of the century, which, owing to the special position of the dollar as the global reserve currency, created the conditions for a credit boo

Low interest rates fed the demand for credit, while financial innovation increased its supply. The explosive growth of the market for complex mortgage securities was driven in large part by a desperate search for yield at a time when interest rates were at multi-decade lows.

Yet Bernanke’s analysis ignores the fact that the riskiest subprime loans were priced off short-term rates, including the option of adjustable-rate mortgages with their negative amortization feature (in which interest was rolled up with the principal).

Nevertheless, the monetary tightening had one unintended consequence. Higher rates in the United States, in particular the generous interest offered on margin loans, caused the flow of international capital to reverse direction. American investors now pulled their loans from Europe, while Europeans stepped up their lending to Wall