## Investment Restraint, The Liquidity Glut, and Global Imbalances: Remarks by Raghuram G. Rajan, Economic Counselor and Director of Research

_IMF News, November 16, 2006_

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## Bibliographic details
- Published: November 16, 2006

---

### Overview
- Speech delivered at the Conference on Global Imbalances organized by the Bank of Indonesia in Bali, November 16th 2006.
- Argues three global ingredients explain low long-term real interest rates and large global imbalances:
  - A widespread surge in productivity.
  - A high desired savings rate, particularly supported by corporations and emerging market governments.
  - Global investment in physical assets that has not returned to past levels (termed "investment restraint").

### The Productivity Revolution
- Key observations:
  - Fourth year of strong world growth (context: speech dated November 16th 2006).
  - Productivity growth fostered by information technology and global supply chains.
  - Rapid worldwide productivity growth explains: strong commodity demand; ability of emerging markets to withstand commodity price increases; contained inflation despite rising raw material costs; buoyant household incomes and corporate profits.
  - Emphasizes that productivity surges occurred not only in the U.S. (since 1995) but also in emerging markets.

### The Rise in Desired Savings
- Findings on savings behavior:
  - Household savings in many industrial countries have drifted lower, with exceptions like Germany.
  - Industrial country corporations have increased excess savings (undistributed profit less capital investment) — see WEO September 2005.
  - Drivers of corporate excess savings:
    - Productivity growth not paid out to labor, raising corporate profits.
    - Lower corporate taxes and decreasing dividend payments.
    - Corporations maintaining large cash hoards amid increased firm-level volatility.
  - Emerging markets:
    - Governments running primary fiscal surpluses in some cases (supported by commodity export gains).
    - Households increasing savings due to uncertainty and limited retail credit (example explicitly: China).
    - Emerging market corporations, especially in natural resources, building excess savings.
- Conclusion: continuing high desired savings among households, corporations, and governments—especially in emerging markets—is the second key ingredient.

### The Fall in Realized Investment
- Central puzzle: despite high productivity and savings, physical investment remains subdued.
- Explanations considered:
  - Working off past excessive investment (e.g., telecoms overinvestment in late 1990s).
  - Shift from hard physical assets to intangible investments (training, R&D) that are expensed and not easily tracked; but corporate profitability remains high.
  - Capital goods prices falling (e.g., computers) — counterarguments:
    - High depreciation rates of rapidly cheaper capital goods.
    - If cheaper, firms should buy more, not less.
  - Economic and political uncertainty deterring investment, especially in emerging markets.
  - Offshoring: industrial-country firms investing more overseas (FDI in emerging markets near an all time high) rather than domestically; uncertainty about long-term predictability of non-industrial country environments may limit long-term, hard-to-move investments.
- Conjecture: global investment restraint and limited greenfield FDI from rich countries to emerging markets may reflect political and economic uncertainty.

### The Global Liquidity Glut
- Mechanism:
  - Low flow of new collateralizable hard assets constrains debt issuance.
  - If investment shifts to non-securitizable assets (e.g., firm-specific human capital), it reduces collateral available for finance.
  - Result: mismatch between high desired savings and low realized investment creates a liquidity glut, pushing long-term real interest rates lower globally.
- Market implications:
  - Excess liquidity spills into existing real and financial assets (real estate, high-risk credit, private equity, art, commodities), raising prices.
  - Illiquid markets have been pushed up most by small infusions of liquidity.
  - Emerging market debt becoming mainstream partly because of shortage of new investible assets rather than solely improved creditworthiness.
  - Easy refinancing can create self-fulfilling reductions in defaults and perceived credit risk.
- Role of monetary policy and foreign official flows:
  - Rajan argues G-3 accommodative policy is not the primary driver of low long rates; policy rate changes had limited effect on long rates.
  - Foreign central bank purchases of U.S. assets reflect domestic savings-investment imbalances and are not necessarily the direct cause of low U.S. long rates (see Warnock and Warnock (2006)).

### The Liquidity Glut and Global Imbalances
- How differences in domestic financial structures shape current accounts:
  - United States: surge in productivity translated into late-1990s investment boom; since 2002 expansion more consumption- and real estate-focused, enabled by deep, arm's-length financial markets allowing borrowing against future incomes. Result: large current account deficit (also see WEO September 2006).
  - Emerging markets: cautious investment after past booms and busts; limited housing and retail finance constrain household consumption; results in net savings/current account surpluses. Exception: India moved from surplus to increasing deficit due to a more vibrant financial sector.
- U.S. financial innovation and securitization drew global savings into the United States, helping support the dollar amid a worldwide shortage of investible assets.

### How Will All This End? (Scenarios and adjustment channels)
- Long-run tendencies:
  - Low real interest rates may be more representative historically than the high rates of the previous three decades (see Catao and Mackenzie (2005)).
  - Demographics (aging populations in developed countries) imply rebalancing must occur primarily in non-industrial countries.
- Channels for adjustment:
  - Increased foreign direct investment into emerging markets.
  - Development of financial systems in emerging markets to intermediate savings into productive investment.
  - Rising consumption as safety nets improve and retail finance expands, reducing desired savings.
  - Demographically-driven changes forcing reversal of the perverse pattern of net capital flows from poor to rich.
- Risks and dangers:
  - Financial innovation creating too many assets of one class leading to gluts and abrupt corrections (example: US housing market correction risk).
  - Agency problems in financial systems amplified by cheap and easy finance.
  - Small changes in excess liquidity can cause large swings in prices of illiquid assets and valuations.
- Policy implications:
  - Ensure government policy does not impede adjustment; IMF efforts aimed at this objective.
  - Continued caution is warranted because adjustments rarely proceed smoothly.

### Conclusions and Policy Recommendations
- Summary conclusions:
  - Fundamental forces—productivity surge, high desired savings, and investment restraint—explain both global imbalances and the global liquidity glut.
  - Hope for gradual correction: long-term interest rates moving up slowly, exchange rates adjusting, and global imbalances narrowing without major blow-ups.
- Policy recommendations and cautions:
  - Facilitate the development of emerging market financial systems to channel savings into investment.
  - Improve safety nets and retail finance in emerging markets to reduce precautionary household savings.
  - Monitor and manage financial innovation to reduce the risk of asset-class overshooting and agency problems.
  - Avoid government policies that impede necessary real and financial adjustments.
  - Maintain vigilance given the potential for abrupt corrections in illiquid asset markets.

*Remarks by Raghuram G. Rajan, Economic Counselor and Director of Research, IMF. November 16, 2006.*

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## References

- [People's Republic of China and the IMF](http://www.imf.org/external/country/CHN/index.htm)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [Raghuram G. Rajan](https://www.imf.org/external/np/bio/eng/rr.htm)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp111506_