

Free exchange

Savers’ lament

The complex effects of low interest rates on consumption and investment

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Readers' comments




Just one thing to consider for the saving of middle income people:
Many take their retirement-income so import that they react to lower interest rates by INCREASING their savings in order to reach a desired continuing level of living. Saving is kind of a Giffen good.
To reduce this effect, central banks should increase interest rates while at the same time use quantittive easing and other innovative methods to ensure that there is no shortage in the money supply.


On the issue of effectiveness of monetary policy: I love the OP's discussion
of pension obligations, forcing firms to set aside ever more cash (in
government bonds, etc) as lower interest rates cause pension deficits to
boom. That's a very large part of what gave Japan two decades of relative
stagnation (and well into a third).

The answer, surely, has to be to separate pension funds from businesses
entirely, and to ban pension funds from selling "final salary" or "fixed
annuity disclosed many years before actual retirement" types of structure.
Any business or bank that promises a fixed income in retirement is committing
fraud: there is no actuarially sound way of projecting life expectancies or
investment returns over the course of two or more decades. And in any case,
your employer should have no part in providing pensions - you want to have
complete freedom in changing your employer (or having multiple employers),
without this having some arbitrary impact on your retirement fund. Businesses
should focus on core activities: efficiently in innovating and delivering
particular services to particular markets, rather than the bureaucracy of
managing investment funds for each and every employee (sounds like yet
another barrier to entry, as well as a drain on ability of businesses to
invest when interest rates fall).

shaun39 in reply to 3SPKuHLzMC

Yep - I really like the idea of shifting entirely to electronic cash, and having electronic cash decay by 5% or so annually (naturally).

The central bank then pays interest on deposits of electronic cash (perhaps entirely overcoming the decay) that financial institutions (or regular businesses; or regular consumers) make with the central bank, as part of monetary policy.

Deposit insurance is only provided on money denominated accounts which offer interest below a threshold (e.g. 100 basis points above the central bank rate).

For anyone who wants to make an actual return on savings, that must then take place through investing in real assets, with denominations other than money (i.e. with genuine stakes in the underlying assets). With savers assuming the full risk inherent in their assets, there would hopefully be fewer bad investments. And with money operating primarily as a medium of exchange rather than a massive bubble asset in itself, we would actually have market clearing between savings and investment/ borrowing.

Well, perhaps. Monetary & banking reform in this direction would certainly be interesting, and worthy of experimentation - anyone friendly with an African dictator that might be happy to try this out?


One of the problems with money is that we treat it as a commodity - something which has a value of its own. Every time I use the bank's ATm I told to let the bank put my money to work for me (and the bank).

We would have fewer macro financial problems if we were to think of money as a tool that facilitates the exchange of goods and services. It is a concept which represents purchasing power.

One of the things I like about local exchange trading systems (LETS) is that they create money that only facilitates exchange. It has no value of itself and there is no interest involved.

This is in contrast to fractional reserve money which is based on debt issued by banks and upon which interest is charged.

In a fractional reserve system when we deposit money in a bank or make a loan to somebody we are transferring purchasing power to somebody else. We do this expecting a return of even more purchasing power. But this additional purchasing power is an illusion. It comes at the expense of somebody else or it leads to inflation.

When the economy is growing more goods and services are being produced so there is extra to be purchased and the problem is not so obvious. When the economy is stagnant there are no extra goods and services to be distributed and this is showing up in the form of low interest rates.


Tom Avery

Interest rates should be not tax deductible for both business or personal. Any tax deduction is a subsidy by government that favors borrowers. Since 1986 US tax reform, we have not allowed consumer interest to be deductible. We mistakenly created a monster of a problem by allowing the home equity line of credit to become the main source of tax deductible consumer credit.

The elimination of tax deductions or the substantial reduction of interest expense under a max total personal deduction formula of say $50,000 per year, could allow for the possibility of no personal income tax on interest to a limit of $50,000. Taking a tax deduction of any amount of the $50,000 max offset any of the interest exemption provided. Therefore you can not double up on taking both a deduction and an exemption that in total exceeds $50,000.

All this is done to diminish the tax code favoring the borrower at the savers expense. The limits would probably raise government revenue.


One very destructive effect of the current low interest rate environment is that it is artificially inflating the price of homes.

People tend to purchase a home based on monthly payment not absolute price. As such, as interest rates decline the price of homes rises. Essentially, a purchaser pays less to the bank through lower interest, but that is mostly offset with a higher purchase price to the property seller. The monthly payment stays relatively unchanged.

So what happens when the current 3% 30-year mortgage returns to the 7%-8% level? Without an offsetting increase in wages, higher interest rates will reduce the price of homes by at least 30%. In fact, it would take a 57% increase in wages to offset an increase from 3% to 7% if you want to just keep housing prices flat. At 3% annual increases, it would take 15 years for the average person to receive a 57% wage increase. Hyper inflation would be needed to see any faster results.

Your best bet on housing, on average, is to assume flat prices for the next few decades, at least in the bubble markets like California, Nevada, Florida, etc. Certainly there will be exceptions, but they will be few.


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