A tightening of monetary policy now appears to be on the horizon in North America. But anyone hoping for a return to the higher rates of years past shouldn't get too optimistic. When rates rise, they will likely top out at well below pre-Great Recession heights.
That's the conclusion of a new paper by the C.D. Howe Institute. Authors Paul Beaudry and Philippe Bergevin argue that even after rates start to rise in Canada, the "new 'normal'" will likely be lower than the historical average, and remain so for the next decade.
The Bank of Canada's old normal, according to the authors, was a target overnight rate averaging 3.8 per cent from the end of 1995 – when the bank adopted its 2 per cent target inflation rate – until the recession began in late 2008 (The target rate, which stood at 4.25 per cent on Jan. 1, 2008, was down to 0.25 per cent just 16 months later).
That seems like a lifetime ago, certainly for savers who have seen yields from "safe" investments like government bonds drop into negative-return territory after inflation. The miserly returns have also been a blow to defined-benefit pension funds and insurance companies, for which lower rates translate into larger long-term obligations.
The implications have been huge: Investors have been forced to chase higher returns from riskier investments while employees have had to contribute more to their pension plans as they see their future benefits squeezed and as pension fund managers battle the raging shortfalls that lower rates have wrought.
Economists have coined the term "low for long" to describe this period, but perhaps they should add "and not much higher after that." The authors of the C.D. Howe report argue that rates will remain low based on the notion that the stronger that demand is for savings in relation to demand for investment, the lower rates will remain.
The authors see three reasons why the demand for savings will remain strong. First, there is "a large cohort" of baby boomers heading toward retirement and setting aside more for saving as opposed to spending. The period when the bulk of boomers start drawing down on their savings won't happen for at least three to 10 years, they say.
China is another factor. With little of a Western-style safety net, Chinese households save a huge proportion of their wealth – and this elevated savings level will only increase as the middle class grows.
Finally, the after effects of the Great Recession have included U.S. consumers saving more and borrowing less, governments cutting back spending, and businesses holding back on investment. "Continued low desired investment will therefore exacerbate the effects of high desired savings on interest rates," the authors say.
Rate increases may be coming, but they will be small and incremental. The post-Great Recession period has been dubbed "the Great Frustration" by one central banker, and few are as frustrated as the savers who've suffered – and will continue to do so – in the low rate environment.