Are low interest rates bad for the economy? (Part II)

By Barbara Kiviat | August 11, 2010 | +

Investment manager John Michaelson has an interesting op-ed in today’s WSJ. He argues that super-low interest rates, which the Fed re-committed to yesterday, may be hindering, not helping, economic growth.

There are plenty of reasons to not like low interest rates. For one thing, they help cause asset bubbles. For another, they hurt people and organizations—like seniors and non-profits—that depend on funding from fixed-income investments. For a third, they penalize people who are trying to do the financially responsible thing and save.

But Michaelson comes at this from an entirely different angle: he says that low interest rates are part of the reason companies are sitting on cash instead of investing. He says they’re part of the reason we’re not seeing more job creation.

Here’s the core of his argument:

Banks are able to make adequate returns by borrowing at near-zero rates and investing almost risk free and without effort in longer-term government debt, federal government-guaranteed debt, or in relatively riskless investment-grade debt—all at 3% to 4%. They have little incentive to go out and make loans to job-creating businesses that might have a higher yield but entail significant risk and effort… Paying higher rates to attract deposits will force banks to look for lending opportunities beyond government type credits.

In other words, there’s not a whole lot of reason for banks to drum up business.

And from the corporation side, there’s not a whole lot of reason to knock down banks’ doors. With demand for products and services still fairly slack, companies aren’t chomping at the bit to build more factories and hire more workers. The low interest rates that are supposed to entice them to do those things aren’t, Michaelson writes, because, as any CFO can tell you, whether credit is slightly cheaper or slightly more expensive just doesn’t matter enough to tip the decision.

Steve got at this in a post back in June. And Liaquat Ahamed and I talked about it a year and a half ago. Monetary policy is a pretty blunt instrument, and it can only do so much. If the economy is sluggish, people won’t want to spend money. If interest rates drop by a huge amount, that might get attention, but keeping them at 0% month after month after month shouldn’t be seen as a solution. It might even be the opposite.

Related Topics: Wall Street Journal, Economy & Policy

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Rick Russell

Low interest rates can be a strategic decision when your economy is otherwise quite strong, e.g. Japan. But when hiring is frozen and consumption is down, you’re basically sending the message, “It’s bad and we don’t think it’s getting better. Here, have a stack of money and see if that helps.”

That’s a pretty bad signal to businesses that will significantly increase uncertainty and risk premiums.
http://rodgermmitchell.wordpress.com Rodger Malcolm Mitchell

” . . . because, as any CFO can tell you, whether credit is slightly cheaper or slightly more expensive just doesn’t matter enough to tip the decision.”
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Exactly correct. Low interest rates do not, will not, and never have stimulated the economy. I’ve written about this many times.
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The fed raises interest rates when it fears inflation and it cuts rates when it fears recession. But inflation is not the opposite of recession, so doing the opposite doesn’t work. Greenspan’s and Bernanke cut rates 20 times in a futile effort to stimulate the economy. They learned nothing from this misguided exercise.
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Their theory was that low rates stimulate borrowing. But, they forgot that low rates also inhibit lending. It’s a two-way street. For every stimulated borrower, there’s an unstimulated lender.
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And by the way, why do so many people want the banks to lend more (i.e. the private sector to borrow more), when simultaneously, these same people want the federal government to borrow less? It makes no sense, particularly since private borrowers can go bankrupt and the federal government cannot.

Rodger Malcolm Mitchell
http://stephenpoo.wordpress.com stephenpoo

By the time consumers are dug out and ready to make that big financed purchase rates will have long ago went up anyway. You can’t win, but hey can we start a Bank and do what the rest are doing lending it back to the Government. Isn’t that sort of Rube Goldberg-ish
atworkforu

This is profoundly misguided. Do not post again until you read some Krugman.
http://wbestes.wordpress.com wbestes

Poor old retirees cannot do anything to stimulate the economy as interest rates on secure savings do not allow one to earn anything to spend. When I looked at retirement in the early 90′s I was told to plan on my money earning 8%. Being conservative I made my projections on 5% money. Good luck with that. My children who are all under 50 and employed will be lucky to ever retire as the good old stock market over the past 10 years hasn’t returned enough that their saving won’t grow to allow them to ever retire.
deconstructiva

Barbara, thanks for this post. It looks like rates will stay low for awhile so what can we do to grow our nest eggs NOW? Comparing your post to Stephen’s recent one (today’s market) offers great questions for pondering. If you’re still reading these comments this late (and if you are, you must really love our annoying comments, but I digress), the first q. would be: given today’s crappy savings rates, can the stock market still offer better results? Perhaps by stressing dividend-paying ones over price appreciation, etc.? What do your regular sources (and tarot cards) offer as best overall options if savings rates stay too low? I asked Stephen for his thoughts (NOT stock picks, not even Jim Cramer always offers perfect picks, ha!) and would like yours too. Thanks for your excellent posts here, Barbara.
atworkforu

I got a couple more seconds now that I’m off work to point out how dumb this is. My guess is (can’t read the WSJ article) that the WSJ is carrying water for Republican darling Paul Ryan, and Barbara can’t read through the flimflam. Here is the Krugman takedown – http://krugman.blogs.nytimes.com/2010/07/30/dont-know-much-about-economics/

“the Fed funds rate basically equals the return on federal paper, so that raising that rate would make banks more, not less, likely to stay with that federal paper. I’m sure someone will try to come up with a reason why Ryan is being smart here, but the truth is that he’s stone-cold ignorant.”

And obviously there is plenty of money out there for making investments – just not that many good investments due to slack demand. Low interest rates encourage spending – would you rather have a new TV or a CD that is paying 0.5%?

I feel bad for anybody who was counting on decent risk free returns for their retirements, but then there is lots of misery to go around at this time.
angelinacg02

It is very nice article.i think low interest rates are not bad for the economy.
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Green Business
pneogy

Krugman has made the point that businesses are not making new investments because the ‘real’ interest rates are still too high. His suggestion is for the Fed to revise inflation goals upwards, reducing real interest rates, and forcing businesses to take on a little more risk.
http://stephenpoo.wordpress.com stephenpoo

Dear Barbara:
In regards to the parphrase of Michealson: where Banks borrow from the fed and then lend back to the Government. Certainly not the first time this has been mentioned, but the whole process seems like a Marx Brothers skit or maybe Saternight live, but it would seem too over the top.
So how are we to make sence of this, what are the mechanics and motivation. I think its only the largest Banks able to do this but why does the Government hand them a check in one hand and take it back with the other, then pay them interest? Originally we were told it was to stimulate lending which makes sense so why then do they accept it back?
Are these Banks in such desprite shape that the Government has to prop them up with a two or three percent cushion?Or is it something else entirely. I hope you can write about this in some depth.
Thanks and happy hunting.