At the last Fed policy meeting on March 13, the FOMC vowed once again to keep the Fed Funds rate near zero until late 2014. The Fed seems to believe that this policy of extremely low rates will be most conducive to economic growth. But it does not appear to be working. As a result, some economists are starting to question this policy, viewing it as evidence of “financial repression” that may be hindering growth.
Interest rates have fallen sharply over the last several years. In 2006, the prime rate charged by banks to their best customers was nearly 8%, new mortgages were close to 7% and rates on risk-free Treasury bills were near 5%. Lately, the prime rate has been 3.25%, new mortgage rates are slightly over 4% and the rate on short-term Treasury securities is barely above zero.
The Fed Funds rate – the rate that banks charge each other on overnight loans – is also barely above zero, down from near 5% in 2006. In theory, low interest rates should stimulate growth because businesses will borrow to invest in new plants and equipment, and both businesses and consumers will refinance loans to free up cash flow and increase disposable income.
Over the last several years, the Fed’s low interest rate policy has sharply reduced personal income. In 2008, people earned $1.4 trillion in interest income, or 11.1% of total personal income. In 2011, interest income fell to $1 trillion and represented just 7.7% of personal income.
If people were still receiving as much interest income in relative terms as they were in 2008, total personal income would be about $450 billion higher. More than likely, personal consumption spending and GDP would be higher by about the same amount. That would have given the economy a much better rate of growth, rather than the weak recovery we’ve seen.
Quite simply, there are two sides to the low interest rate coin. While it lowers the cost of borrowing, it also lowers interest income. And while the debt service ratio for households has fallen, so has the growth of debt. In the early 2000s, household debt grew at double-digit rates, whereas over the last four years, it has grown at a negative rate, as people paid down and paid off more debt than they acquired. While debt may have grown too much in the past, it may be growing too slowly now to fuel strong economic growth.
Some economists are starting to focus on the low level of interest income as a key factor in slow economic growth. They note that those individuals most likely to depend on interest income, such as the elderly, have been forced to cut back sharply on their spending.
Alternatively, savers must seek out riskier investments than they would prefer in order to get a decent rate of return. Many believe that this is a big reason why the stock markets have soared since early 2009, and I wholeheartedly agree.
Other economists, such as Carmen Reinhart (co-author of This Time Is Different with Kenneth Rogoff), believe we may be seeing the beginning of what she calls “financial repression”—a deliberate government policy of holding down interest rates in order to make the federal debt more bearable.
While this may help the federal government, it comes at the expense of consumers and perhaps economic growth as well. You’d think they could figure this out. Or maybe they did! Alas, the high cost of cheap money.
For more on our federal debt woes, CLICK HERE to read this week’s E-letter on that very topic, in case you missed it.
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Tomorrow morning we get the March unemployment rate. The pre-report consensus is that the number will remain at 8.3%, although some forecasters are looking for a decrease to 8.2%. Still others believe it will creep higher because more people are actively looking for work. We’ll see.
The stock markets in the US will be closed tomorrow for the observance of Good Friday, so it will be Monday before we know the reaction to tomorrow’s much-anticipated report.
On a personal note, Easter weekend is a special time for my family. The kids will be home. I’ll be smoking various meats for 20-25 people, as usual. We’ve kept up the tradition of an Easter egg hunt on Sunday afternoon, even though most of our kids are college-aged. We hide several hundred plastic eggs over several acres, and at the end of the hunt, the kids use their eggs as currency to bid on numerous prizes that the parents have brought. It’s a lot of fun to see how much they’ll bid for the various prizes!
Good friends, good food and good fellowship – that’s what it’s all about.
Have a great weekend everyone!
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