Tuesday, August 28, 2012

The Drop in Personal Interest Income

Low interest rates are good for borrowers, but lousy for savers. Here's a graph showing personal interest income, which dropped by about $400 billion per year--a fall of more than one-fourth--as interest rates have plummeted.  

FRED Graph

One of my local newspapers, the (Minneapolis) Star Tribune, offered a nice illustrative set of anecdotes in a story last Sunday about this consequences of this change for those who were depending on interest-bearing assets--often those who are near-retirement or in-retirement, and who want to hold safe assets, but who are receiving a much lower return than they might have expected.
 Moreover, as the article points out, it's not just individual savers who are affected. Pension funds, life insurance companies, long-term care insurance companies, and others who keep a substantial proportion of their investments in safe interest-bearing assets are receiving much less in interest than they would have expected, too.

I'm someone who supported pretty much everything the Federal Reserve did through the depths of the recession and financial crisis that started in late 2007: cutting the federal funds rate down to near-zero percent; setting up a number of agencies to lend money to make short-term liquidity loans to number of firms in financial markets; and the "quantitative easing" policies that involved printing money to purchase federal debt and mortgage-backed securities. But the recession officially ended back in June 2009, more than three years ago. It's time to start recognizing that ultra-low interest rates pose some painful trade-offs, too. Higher-ups at the Fed were reportedly saying back in 2009 that when the financial crisis was over, they would unwind these steps--but with the sluggishness of the recovery, they haven't done so.

 A year ago, for example, I posted on Can Bernanke Unwind the Fed's Policies? I posted last month on "BIS on Dangers of Continually Expansionary Monetary Policy," in which the Bank of International Settlements states: "Failing to appreciate the limits of monetary policy can lead to central banks being overburdened, with potentially serious adverse consequences. Prolonged and aggressive monetary accommodation has side effects that may delay the return to a self-sustaining recovery and may create risks for financial and price stability globally."

I lack the confidence to say just when or how the Fed should start backing away from its extremely accommodating monetary policies, but after jamming the monetary policy pedal quite hard for the last five years, it seems time to acknowledge that monetary policy in certain settings like the aftermath of a financial crisis and an overleveraged economy is a more limited tool than many of us would have believed back in 2006. Moreover, the U.S. economy has a very recent example from the early 2000s in which the Federal Reserve kept interest rates too low for too long in the early 2000s, and it helped to trigger the boom in lending and borrowing, much of it housing-related in one way or another, that led to the financial crisis and the Great Recession. The dangers of ultra-low interest rates and quantitative easing may not yet outweigh their benefits, but the potential tradeoffs and dangers shouldn't be minimized or ignored.