Low Interest Rates Aren’t Always Good for Consumers

Since 2008, the Federal Reserve has been using very low interest rates to try to stimulate the economy, a policy that has had mixed results, especially in the longer term. Low interest rates are supposed to be good for consumers who can refinance mortgages at a lower rate and get lower interest on loans. While generally true, this analysis neglects the fact that consumers can get little or no return on their savings at the bank and only very low returns on investment-grade bonds. To get any significant return, consumers must accept a significant level of risk, whether in junk bonds, stocks, or other investments.

Clearly, borrowers benefit most from very low interest rates. But, contrary to what one might think, the biggest borrowers are governments and then businesses, while consumers actually have substantially more assets, on which they are either getting low or risky returns, than liabilities. Thus, governments, in particular, and businesses, experience net benefits from these very low rates, while consumers as a class, experience net losses. (See Business Insider for more information on this topic).

Contrary to conventional economic expectations, consumers are actually saving more because of the low returns on their savings. The reason for this paradoxical behavior is that consumers’ savings rate is primarily determined not by the return on their savings, but by the desire to accumulate a certain level of wealth, whether for anticipated future expenses or for retirement. Thus, low interest rates actually require consumers to save more to reach their wealth targets.

Accordingly, consumers would actually benefit from a moderate increase in the Federal Reserve interest rate target.

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