By Jessica Wagner
Earlier this month, the announcement came that American’s triple A credit rating was being downgraded to double A plus status. The Federal Reserve announced that it was making no plans to raise the near zero interest rates that have been set in place for some time now. This announcement came on the heels of the worst drop in market shares since the market collapse that happened back in 2008.
It seems that the FED isn’t planning to raise the interest rates for the foreseeable future and the near zero figure is likely to stay in place for another two years. This has many in the private and public sector seriously concerned as it’s widely seen to be a major factor in sustaining such poor economic results. Keeping the rate low was seen as a way to inspire investment growth, but it appears to have had the opposite effect and seems to be hurting the economy’s ability to recover.
What the Fed HOPED low interest rates would accomplish
This decision wasn’t made lightly, and the Federal Reserve stated that this decision was made based on the grim outlook for the U.S. Economy. After the announcement was made, the market fluctuated greatly and many in the industry were unsure as how to react to the news. The decision was made with the intention of helping out an incredibly weak economy that’s seen static investment and job growth.
Though some areas of the job market have seen bright spots like in nursing schools, most sectors are lagging far behind. The FED wants to buy more Treasury bonds to keep the long-term rates low until things improved, but this move is the sign of a market that has no idea how to come back in the face of such overwhelming issues. Many argue that such a move is good in the short-term but makes for an incredibly poor strategy when you take the overall market into account.
The low interest rates do assist in some areas of the market and this was the hope when the FED made their decision to extend these rates. When the low rates are set in place, it makes it easier for people to receive low fixed-rates on mortgage loans and makes it cheaper to get business loans. This is one positive for the economy, but it doesn’t seem to be working.
Zero interest rates are having the opposite affect
Sales of existing homes dipped in the second quarter and have seen very little movement forward this year. This is due to the increased difficulty for individuals to qualify for a home loan, a factor which is more than offsetting the benefit that would ordinarily be provided by such low mortgage rates. Banks are far less liberal with their lending practices and people, as a whole, are taking a wait and see approach. The move to keep rates low was intended to help, but it only seems to be making a bad situation worse. Perhaps it is that rates so low offer little protection for lenders in the event of borrower default, contributing to strickter loan qualifications.
When you keep interest rates low for such a prolonged period of time, you create stagnation in the market. Where, in some areas, low rates help out buyers, it has the opposite effect for investors. People who’ve invested in treasury bonds and other assets are seeing almost no growth with their investments.
People saving for retirement and other purposes are gaining no traction with their money. And perhaps no group has been more negatively affected by low rates than the elderly, who were counting on interest income to help pay for retirement. Retirees are being forced to either participate heavily in the stock market—with all the risk that goes with it—or to draw down on their investment principal. That last step is having a negative affect on the economy as the nation’s savings base dissipates.
While rate easing and near zero standards might have some salutary effect, it’s only useful in the short-term. These policies create a long-term toxic environment for the financial sector and decrease consumption over all. This low interest approach will not lead to improvement, but will likely lend further to an even larger and deepening economic malaise that will continue for the foreseeable future until more bold economic policies are set in place.
What do you think about low/zero interest rates—are they helping the economy or hurting it?
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The Fed is targeting low rates to force people to spend their money. Inflation is low, so the Fed is attempting to get people to spend money.
“People saving for retirement and other purposes are gaining no traction with their money. ” This is part of the problem. Americans are putting their money in savings accounts instead of investing or spending it. This change in behavior is dampening demand. If you want to know why recovery is slow it’s because of the downward shock in demand as consumers stopped spending borrowed money and started saving.
If you want to see a decrease in consumption, imagine how many people would be able to afford their homes if interest rates were 8%. You want to see a real estate crash, have the fed raise the funds rate back above 4%. Look at the chart, and the timing with the housing collapse. The problem isn’t’ that rates are low, it’s that they were raised too quickly in 2005-2007 precipitating a collapse in demand.
Hi Alpha–There’s a lot of truth to what you’re saying. The Fed is in a no win situation; low rates aren’t working, but higher rates will probably kill off what ever is left of the economy. I continue to be disturbed by the fact that the housing market is doing so poorly with fixed rate mortgage money well below 5%. At any other time in the past 50 years rates that low would have sparked an explosion in both sales and price levels. Something more is taking place here.
I do believe that zero rates are hurting the savings base though, which is hurting the economy as well. Retirees are the biggest savers and if they have to dissave in order to pay the bills–because interest rates are so low–that will hurt the economy.
I think this is an important time for people to re-tool, and saving money, though it may be a drag on the economy, is a necessary part of that transition. The future is shaping up to be quite different from what we’ve known in the past, and I think people cutting back on spending is evidence that the majority of people sense a significant change. I also think re-tooling careers is part of the change. The fields that have worked in the past may not in the future. Health careers, IT, self-employment, etc are probably the way forward, and people are going to have to consider making career transitions going forward.
Long-term, low interest rates are a poor substitue for sound governance and responsible fiscal planning. Japan tried it in the 1990s and it didn’t work out too well. Nobody in Washington has the courage to stand up and do the right thing for the economy. So, they are using misguided stimulus and ineffective measures by the Fed to make up for it.
Honestly, they don’t have a lot of attractive options right now. The massive deficits and COLA based entitlements are forcing the Fed to understate inflation and keep interest rates low. And, the banks are feasting on the huge spread between the savings rate and credit card interest rates.
The banks and our government are stealing from everyone who owns a dollar.
Hi Bret–I wish I could say that I disagree with what you’ve written but I don’t disagree with any of it. It seems that the whole economic structure is hanging on super low interest rates. It’s frightening to contemplate how bad things could get if rates were to suddenly spike–think about housing that’s bearly breathing with fixed rates of 4.something.
Still low rates are making saving money close to pointless. You can’t earn anything on savings (riskfree) so you may as well spend. Short term that may be keeping the economy moving, but as the capital base withers away, so will spending, eventually. One has to suppose that the government, as by far the biggest debtor, has the most to gain with near zero rates.
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