Many people are increasingly frustrated by the Federal Reserve’s zero interest rate policy because of its harmful effects on middle-class savers. It’s not clear how much it’s helping the economy and it is reducing returns to people trying to save for their future.
For example, since January 2009, the return to investors holding the Vanguard Prime Money Market Fund, with over $100 billion, was a total of less than 1%. For the 20 years prior to 2009 a number closer to 4-5% per year was the norm. Older savers were counting on this fund for liquidity and safety. Someone with $100,000 in the fund should have earned a minimum of $20,000, instead they earned $1,000. The complaint is that their income was confiscated by the US Government so that the government could continue to deficit spend. Who got that $19,000? Why should savers be forced into risky equities to save for their futures?
I would like to share some of my thoughts on the zero interest rate policy to answer some of these questions.
The interest rate targeting policy has been the primary tool for the Fed to stimulate the economy. If we take a look at recent past efforts to forestall recessions we will see that it had usually dropped more than 5%. For instance, during the recession of the 1980s and the dot.com bubble in early 2000s rates fell by 10% and 5%.
In order to put the brakes on an overheating economy before the housing bubble burst, the fed funds rate was raised to a little bit above 5%. After the crisis, all the Fed did was to implement its conventional policy by lowering the fed funds rate. The Fed didn’t arbitrarily decide the short term interest should be near zero this time. By lowering the rate by 5%, it happened to be around 0%.
Secondly, people using money markets to produce savings need to consider the real rate of return. When the hypothetical saver received around 5% per year interest over the past 20 years prior to 2009, the inflation rate was higher than now (on average 3% inflation in the past 20 years prior to 2009, compared to 1.6% inflation after 2009). The real interest rate in the past 20 years is not as high as 5% (the real return approximately equals 5%-3%=2%). Also, when interest rates are low, the asset price is high. The money market fund could be sold at a higher price to receive capital gain.
I don’t believe the Fed lowered the interest rates in an effort to benefit federal government spending (I am not defending the Fed, but it is the fact). The efficient way to lower interest rates is purchasing large scale bonds or securities to push up the price of assets and the US Treasury happened to be a big borrower due to the big national debt problem. The zero interest rate caused the Fed to switch by from interest rate targeting to money supply targeting. It is also because Ben Bernanke is an expert on the Great Depression and the major cause of the Great Depression is believed to be lack of liquidity. Hence, to deal with this financial crisis, he took whatever it cost to make sure the money supply is steadily growing.
I have great sympathy for those savers who are not willing to take risk by going to the equity market (usually interest rates on money market is negatively related to the equity market). But for a central bank, when the economy is bad, lowering interest rates seems to be the right thing to do. It helps with unemployment, consumption, and investment. But many savers might not care about all of that. Policy makers have to look at a bigger picture when they make decisions. All in all, no policy can serve everyone’s interest.
