A McKinsey Global Institute report examines the distributional effects of these ultra-low rates. It finds that there have been significant effects on different sectors in the economy in terms of income interest and expense. From 2007 to 2012, governments in the eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion both through reduced debt-service costs and increased profits remitted from central bank. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.
With the tapering of QE already on the horizon in the United States and the economic recovery gathering a little momentum in the United Kingdom and the Eurozone, the likelihood of interest rates rising in the years ahead has increased substantially. Indeed, as this report goes to press, rates on ten-year government bonds in the United States have already increased by more than 100 basis points over the past several months. Over the next few years, the benefits gained or losses incurred due to the recent era of ultra-low interest rates could be reversed. Tightening monetary policies and rising rates are likely to create new risks for different sectors and countries around the world.
Once tapering of asset purchases begins and liquidity in the financial system is withdrawn, many market participants are expecting price volatility to increase once again. Market expectations will be the significant driving force as interest rates adjust upward. Rates may overshoot their long-term equilibrium level. In general, this volatility compounds a difficult environment for investors—faced with falling prices in interest-rate-sensitive assets such as bonds, they will tend to sell other assets, particularly those that are traded in liquid markets, causing ripple effects and collateral damage in other asset classes and countries. Moreover, there is a risk that volatility could prove to be a headwind for broader economic growth as households and corporations react to uncertainty by curtailing their spending on durable goods and capital investment.
Government debt service costs could rise by up to 20 percent
Governments in the United States, the United Kingdom, and parts of the Eurozone have issued large amounts of debt over the past five years at very low interest rates. Lower rates have also made it easier for governments to increase the level of their debt, with bonds outstanding rising by $11 trillion since 2007. Today, total government debt service costs are about $780 billion a year in the United States, the United Kingdom, and the Eurozone. Although the average maturity on sovereign debt has lengthened, at the end of 2012 it was still only 5.4 years in the United States, 6.5 years in Germany, and about 6 years for the Eurozone overall. The United Kingdom stands in contrast to this general picture, with a long average maturity of 14.6 years. As debts are rolled over, governments will face higher interest payments as rates rise. For example, we estimate that a 300-basis-point rise in US ten-year government bond yields—which would reverse the decline in government bond yields since 2007—would increase US federal government debt interest payments by $75 billion a year, or 23 percent higher than payments in 2012.64 The Congressional Budget Office in the United States has estimated the impact of rising rates on government debt payments, factoring in its own projections of changes in government deficits. It expects the government’s net interest costs to more than double relative to the size of the economy over the next decade, from 1.25 percent of GDP in 2013 to almost 2 percent in 2017 and to more than 3 percent by 2023.65 In the Eurozone, we estimate that aggregate government debt interest costs would increase by $39 billion a year—10 percent higher than 2012 levels—if interest rates rose by 200 basis points, thus reversing their decline from 2007 to 2012. However, this effect would be very unevenly distributed across countries.
Household Debt Impact