Central bankers cannot find a way to help borrowers without hurting savers
You may have noticed that interest rates (be they bank interest rates, yields on bonds or whatever) are very low. They have been very low for a long time. Interest rates in some countries have even gone negative, whatever that means.
There are logical explanations that economists offer. I understand them. But to me, low interest rates are just like a tax on my savings income. Let me tell you why. And you don’t need to understand economics to get my point.
In the countries I’m thinking of, the central bank sets an interest rate. This is the rate that banks (where you and I deposit money) pay when they borrow from the central bank. Many other interest rates depend on the level of this central bank rate. What that does is to make all short-term interest rates lower, when the central bank reduces its declared rate.
Central banks also do something called “quantitative easing” – a jargon phrase, if ever there was one. Never mind “quantitative” – that just describes the technical method – it’s the easing of borrowing conditions, not just short-term but also long-term, that’s the goal.
A natural consequence of the central bank’s moves is that borrowing money becomes cheaper. And if governments and people can borrow money more cheaply, they’re more likely to do so, and that in turn gives them more money to spend.
So that’s what central banks have in mind: they’re trying to stimulate spending in the economy, and keep the economy growing if it might otherwise look like it’s slowing down.
That’s a good cause, so it’s good news, right? For borrowers, yes. But not for savers!
Suppose the “natural” interest rate that a bank would offer on your savings deposits (the rate that would apply if the central bank weren’t deliberately lowering rates) is 4%. And suppose the actual rate is 1%. You’re losing 3% that you would have been given if interest rates weren’t artificially forced down.
To me, that’s just like a tax. It’s like an increase in income tax rates.
It has the same effect on your after-tax income as paying you 4%, then taxing you at 100% on the first 3% and at your normal tax rates on the remaining 1%. It’s like: “Give the first 3% back to the government.”
So I don’t think of “quantitative easing” as anything but a tax increase compared with normal economic conditions. But of course it’s much more acceptable if the hated word “tax” can be avoided, and even better if a jargon phrase is used instead, because there’s no chance the public will get it.
Another consequence of lower interest rates is that it becomes more attractive to invest money in enterprises that seek growth. Partly this is because the enterprises find it cheaper than before to borrow, so their after-borrowing profits should rise. And partly because their future profits are worth more today, if you’re discounting them at lower interest rates.
So investors are also favored by lower interest rates. And therefore they’re more inclined to invest. (Did you notice how stock markets and property values soared, as interest rates fell over the past decade, before the pandemic?)
By the way, economists often don’t distinguish between savers and investors. I do. To me, an investor is someone who seeks long-term growth and can afford to take the shorter-term risks that inevitably accompany growth-seeking investments. A saver is someone who can’t afford to lose money; for them, short-term certainty is more important, so anything that could go down in the short term is avoided.
Overall, therefore, lower interest rates are good for investors and bad for savers.
As I’ve said, the cost of the stimulus is borne, at least in part, by savers, who get paid less. The old, the poor and the financially illiterate are the most vulnerable – those who can’t afford to lose money, or don’t have the time, sophistication or resources to avoid the obstacles placed in their path. I specifically include people in retirement here, because their planning time horizon shortens as they age; this makes them more risk-averse, so they’re much more likely to be savers than investors.
It’s not that central bankers actively dislike savers. They just can’t find a way to help borrowers without hurting savers. Their tools are very blunt instruments, as they acknowledge.
The cost of stimulus is also borne by future taxpayers, because the increase in debt that results from whatever increase goes onto the government’s balance sheet must be repaid some day. Maybe it’ll be through new borrowing to repay the old loans, or maybe it’ll be through explicitly higher future taxes. But one way or another, the can gets kicked down the road, and future generations will inherit worse conditions than they otherwise would – so that the current generation can benefit.
Yes, I know I’m over-simplifying. But that’s only in the details that I’ve skipped over, for ease of explanation. The basic analysis is accurate. Artificially lowered interest rates are used as an economic stimulus, to raise spending and investment. The immediate cost is borne by savers, for whom it’s akin to an immediate tax increase.
This piece appeared under my name in the weekend edition of the UK Financial Times on June 27, 2020, in the Money section. It appeared in the online edition on June 24, 2020. I was described as “the former co-chairman of global consulting for Russell Investments worldwide, and the author of Life Two: how to get to and enjoy what used to be called retirement.”
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.