Interests Rates

Topics: Federal Reserve System, Monetary policy, Central bank Pages: 3 (1060 words) Published: May 27, 2013
Free exchange
Savers’ lament

The complex effects of low interest rates on consumption and investment Dec 1st 2012 | from The Economist print edition WHEN interest rates hit double digits in the late 1970s, house-builders sent planks of wood to the Federal Reserve in protest. With rates stuck near zero, the protests now come from the opposite direction. The retired complain of a “war on savings”. The Fed cut rates to current levels at the end of 2008 and has promised to keep them there until 2015. Since 2008, personal interest income has plunged 30%, or $432 billion at an annual rate, more than 4% of disposable income. David Einhorn, a hedge-fund manager, likens zero rates to an overdose of jam doughnuts: too much of a good thing. Raghuram Rajan, a former chief economist for the International Monetary Fund, describes the Fed’s policy as “expropriating responsible savers in favour of irresponsible banks”, and thinks it should raise rates modestly. This challenges textbook monetary policy. Typically, lower rates stimulate growth in several ways. They reduce the cost of capital, spurring investment and encouraging households to consume today rather than tomorrow. They also boost stock prices, helping spending through the wealth effect, and reduce the exchange rate, helping exports. Finally, lower rates redistribute income from creditors to debtors, who will presumably spend the windfall. Today’s critics argue that this reasoning no longer applies. Business and households can’t or don’t want to borrow, while the retired and corporate pension sponsors must slash spending to cope with lost interest income. Are the critics right? Start with redistributive effects. These depend on who are the creditors and who are the debtors. For a net debtor nation like America, lower rates raise national income by reducing the flow of payments to foreign bondholders. (The opposite is true for Japan, a net creditor.) Lower rates may also benefit households and companies at the...
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