Financial markets will face a huge stress test in 2023

 With inflation on the rise and the era of ultra-low interest rates over, financial markets will face a huge stress test in 2023. 

While banking systems are more robust than they were in 2008, a real-estate slump could severely affect heavily leveraged private-equity firms, producing a systemic crisis.

Banks that provided much of the funding for private equity real-estate purchases could be on the hook. That has not happened yet, partly because lightly regulated firms are under less pressure to mark their books to market. 

But suppose interest rates remain stubbornly high even during a recession (a distinct possibility as we exit the ultra-low-rate era). In that case, widespread payment delinquencies could make it hard to maintain appearances.

Italy is another example of latent risk. In many ways, ultra-low interest rates have been the glue holding the eurozone together. 

Open-ended guarantees for Italian debt, in line with former European Central Bank President Mario Draghi’s 2012 promise to do “whatever it takes,” were cheap when Germany could borrow at zero or negative rates. 

Kenneth Rogoff Project Syndicate 2 January 2023


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