Many of my white papers have referenced the fact that most economic policies and actions have secondary and tertiary effects, unintended consequences, and quite often, distinct winners and losers. The economic trauma associated with Covid-19 has resulted in government policies that provide a great example of these kinds of twists and turns. Much to my surprise, the issue that I will describe has garnered little or no media coverage despite the fact that it has materially impacted a significant portion of the population. Trigger warning; this is as close as I get to a rant!
Federal Reserve Policy
The Federal Reserve’s primary tool for combatting economic weakness is its control over short-term interest rates. As the magnitude of the Great Financial Crisis became apparent, the FED lowered the FED Funds rate from 5% in August of 2007 to .16% in January of 2009. It stayed at that level until December of 2015 when the FED began a process of trying to “normalize” (increase) rates. However, the stock market had a “tantrum” in the fourth quarter of 2018 causing the FED to reverse course and announce a series of rate cuts from the peak of 2.4% in July of 2019. Then came the CoronaVirus and the FED quickly lowered rates to the current level of .05%. The net result of these policies is that the FED Funds rate has averaged .58% since January of 2009 as compared to the long- term average of 4.75%. (Since 1954)
The rationale for cutting interest rates during periods of economic stress is that low rates motivate individuals and corporations to borrow resulting in the purchase of big ticket consumer goods, housing, and on the part of corporations, expenditures on plant and equipment, research and development, and so on. All of this creates a virtuous circle that increases incomes, reduces unemployment, and stimulates further demand.
So-What’s the Issue?
Basically, an ultra-low interest rate policy attempts to jumpstart the economy at the expense of owners of interest bearing securities. Low rates reduce the borrowing cost for some, but also reduce interest income for others, and those “others” are diligent savers including retirees who rely on the income on their accumulated funds. As I stated at the outset, there are winners and losers. To be blunt, this represents a transfer of wealth from one segment of the population to the remainder. While there is a great deal of media coverage of low interest rates, I haven’t seen any discussion of this transfer of wealth.
How much money are we talking about?
I looked at the relationship between inflation and interest rates over time and calculated that without intervention by the FED, short-term interest rates would have been on average about 2.4% higher over the past ten years given the rate of inflation that has actually prevailed. Money market funds, savings deposits, CDs and other interest bearing securities total about $12 trillion, which when multiplied by 2.4%, suggests an annual loss of interest income of about $290 billion. Now, these are crude numbers and only a portion of the $12 trillion is owned by individuals, so it is difficult to get at the actual cost to America’s 49 million retirees. But, it ain’t chicken feed. And, given recent inflation of about 1%, a saver is losing purchasing power to the tune of 1% per year assuming a zero interest rate.
In both the Global Financial and Covid-19 crises, I believe the FED had to take dramatic steps including cutting rates to essentially zero. I might quibble with the fact that they left them at minimal levels for ten years, but I will leave it to professional economists to debate that issue. But, I do think our policy makers should be honest about what is actually occurring and articulate the economic rationale for having one segment of the population subsidize the remainder.