The Pain of Interest Rate Suppression

In a recent article Michael Aneiro writes about “Rate Suppression’s Painful Side” (Barron’s, July 30, 2012, p. M9). While rate suppression “has been great for borrowers, ” he says, “It hasn’t kick-started the economy, and it’s been a disaster for many investors.”

He explains that “income investors are stuck with the most paltry yields on record and essentially forced by the Fed to invest in dividend stocks or risky bonds to scrape together  yields once found in high grade bonds.”

“Corporate pension funds,” he continues, “are suffering record rates of underfunding, largely due to dismal rates of return, while similar problems have contributed to a spate of municipal bankruptcies in California”.

Last, but not least, “as baby boomers hit retirement age, when investors typically shift money from stocks into bonds, it’s bringing a tidal wave into the fixed-income investing pool just as bond interest rates are near their lowest levels in history”.

In other words, the monetary policy of interest rate suppression, in spite of the lessons from the Great Depression as interpreted by Keynes, has so far produced the very limited overall macro-benefit of pushing on a string. It has, to be true, provided artificially cheap money to banks and borrowers. At the same, it has penalized savers, fixed income investors, and senior citizens.

Though money is now close to free, lunch is not, unless you’re eating somebody else’s.

Dr. Doom & Higher Interest Rates

1. ZB– Dr. Doom is back…

2. FB–I think that they should raise interest rates significantly.

Lower rates are not inducing borrowers to spend and they deprive lenders of income.

Higher rates would provide creditors with income that they would spend.

Further the income would be taxable and help the national debt payoff.

It would cost more to borrow, but nobody is borrowing anyway.

Except the US government.

The marginal gain from higher rates would outweigh the marginal loss from lower rates.

This is Keynesian heresy which is probably wrong and can get one lynched, but I think that you’ll start to see more of it here and there.

3. ZB–It’s like the contra-fund of interest rate policy….

We could call it the ‘contra-rate’ strategy.

4. FB–The Fed philosophy is to reduce rates to make it painful to hold money.

There is pain, but people are holding even more.

If rates were higher people would spend the interest and there would be a positive wealth effect.

Increased wealth effect  produces higher marginal propensity to spend ?

5. ZB–Why wouldn’t people just hold the money + interest.

They don’t like things that cost them money. They like things that cost you money.

They like to take your money and put it in their own pockets – it’s one of the things they like best…

7. FB–In that case, there’s no point in paying you interest, since you’re going to save anyway.

8. ZB–Hence 0% (and/or negative) interest rates…..