Sunday, September 08, 2013

Low Interest Rates, Savers, and the Recovery

This is a brief addendum to my recent post, "Do Savers Need to be Saved?"

Back in March, I wrote about Paul Krugman and Charles Plosser's takes on near-zero nominal interest rates and household saving. Both noted that households were deleveraging and the zero lower bound was binding. Both agreed about Krugman's diagnosis of a "persistent shortfall in aggregate demand that can’t be cured using ordinary monetary policy." But their suggested cures were quite different.

I just came across a piece written in May by Raghuram Rajan, new Governor of the Reserve Bank of India, called "Central Bankers under Siege," that takes on the same issue. He, too, makes a similar diagnosis but suggests different cures. In my post on savers and low interest rates, I discussed the income and substitution effects of low interest rates, and mentioned that near-retirees are commonly cited as examples of people for whom the income effect dominates. Rajan actually uses this exact example:
"First, while low rates might encourage spending if credit were easy, it is not at all clear that traditional savers today would go out and spend. Think of the soon-to-retire office worker. She saved because she wanted enough money to retire. Given the terrible returns on savings since 2007, the prospect of continuing low interest rates might make her put even more money aside. 
Alternatively, low interest rates could push her (or her pension fund) to buy risky long-maturity bonds. Given that these bonds are already aggressively priced, such a move might thus set her up for a fall when interest rates eventually rise. Indeed, America may well be in the process of adding a pension crisis to the unemployment problem."
Rajan and Plosser match up point for point. Here's Plosser:
"In fact, low interest rates and fiscal stimulus spending that leads to larger government budget deficits may be designed to stimulate aggregate demand or consumption, but they could actually do the opposite. For example, low interest rates encourage households to save even more because the return on their savings is very small...
I have heard from various business contacts that the low interest rate environment is spurring institutional and individual investors to “search for yield.” This may entail taking on more credit risk than these investors are typically comfortable with in a reach for yields that may ultimately be illusive and result in losses they are ill-equipped to handle. Very low yields may also be distorting other investment decisions, inducing firms to undertake long-run investment projects that may prove to be unprofitable in a rising interest rate environment."
Both Rajan and Plosser fear that lower interest rates won't help the economy because either the income effect dominates the substitution effect or because low interest rates will cause "reaching for yield." My fellow Not Quite Noahpinion author John Aziz suggests:
"Savers looking for a larger rate of return should... take their money out of low interest savings accounts and out of the failed financial intermediation industry and invest it into quality economic projects that create jobs and growth. This could involve buying the stock or debt of large companies that wish to expand, or it could involve starting your own business, or investing in a startup or a mixture of these things. The easiest way to return to growth — and thus higher interest rates, and higher returns for things like pension funds — is for today’s savers complaining about low interest rates to turn into tomorrow’s investors seeking out and pouring money into quality projects that increase incomes, create jobs and create products that people desire and want to use."
The question is whether low interest rates have the beneficial effect on investment that Aziz describes, or the harmful reach-for-yield effect. Returning to Plosser, Krugman, and Rajan, it is interesting that the three economists seem to diagnose what is ailing the economy quite similarly (a "persistent shortfall in aggregate demand that can’t be cured using ordinary monetary policy"), but make different prescriptions. First, they differ in their opinions of unconventional monetary policy:
  • Plosser: "The first step is to wind down our asset purchases by the end of the year in a gradual and predictable manner. As I said, I see little if any benefit from these purchases, and growing costs. The second step is for the FOMC to commit to its forward guidance on the fed funds rate path, that is, to begin treating the 6.5 percent unemployment rate and the 2.5 percent inflation rate in the guidance as triggers rather than thresholds."
  • Krugman: "Unconventional monetary policy is both controversial and an iffy proposition (which doesn’t mean that it shouldn’t be tried)."
  • Rajan: "We really don’t know. Given the dubious benefits of still lower real interest rates, placing central-bank credibility at risk would be irresponsible."
They also differ in their general policy prescriptions:
  • Plosser wants removal of fiscal-policy-induced uncertainty: "There remains significant uncertainty about the choices that will be made. How much will tax rates rise? How much will government spending be cut? U.S. fiscal policy is clearly on an unsustainable path that must be corrected. Efforts by Congress and the administration at the end of last year reduced some of the near-term uncertainty over personal tax rates. But the impact of the sequester, the debate over the continuing resolution to fund the federal government beyond this month, and the debt ceiling, which will once again become binding in the spring, all have clouded the fiscal policy situation. So, the resultant uncertainty will likely be a drag on near-term growth. In my view, until uncertainty has been resolved, monetary policy accommodation that lowers interest rates is unlikely to stimulate firms to hire and invest."
  • Krugman thinks the fiscal multiplier is large, and fiscal retrenchment would be destructive: "the logic for a biggish multiplier and the logic of the crisis itself are very closely linked: times like these, the aftermath of a credit bubble, are precisely when you expect fiscal multipliers to be large. And that in turn says, once again, that fatalism — or worse yet, demands for fiscal retrenchment — in the aftermath of such a bubble are deeply destructive."
  • Rajan looks to helping households refinance, and (somehow) improving workforce capabilities: "We cannot ignore high unemployment. Clearly, improving indebted households’ ability to refinance at low current interest rates could help to reduce their debt burden, as would writing off some mortgage debt in cases where falling house prices have left borrowers deep underwater (that is, the outstanding mortgage exceeds the house’s value)... But it is also important to recognize that the path to a sustainable recovery does not lie in restoring irresponsible and unaffordable pre-crisis spending, which had the collateral effect of creating unsustainable jobs in construction and finance... Sensible policy lies in improving the capabilities of the workforce across the country, so that they can get sustainable jobs with steady incomes."


  1. Anonymous7:16 PM

    Aziz: To those savers whining that the Fed's ongoing intervention is eating their pie, let them eat cake!

    1. Economist version: Let them maximize utility!

    2. Anonymous3:27 AM

      Economists agree: If only Granny would buy the right hot energy startup stocks with her retirement savings, the magic utility function would let her spend her cake, improve everyone's cake velocity, and eat it too!

    3. Aziz's comment isn't helpful to people on a fixed income. Retirees need SAFE returns. All of his suggestions involve risk, and some of his suggestions involve LOTS of risk (startups? really?!). I'm sympathetic to retirees who did not expect returns on safe assets to fall to near zero territory and were counting on modest income from their savings.

      Of course, that does not mean that the central banks should be raising rates. It just means that Aziz's idea isn't a solution for many people.

  2. So do these guys think central banks have been doing monetary policy backwards all this time? Volker should have lowered rates to stop inflation? Bernanke should have jacked up rates in fall 2008 to stop the financial crisis?

    1. Nathanael3:25 PM

      I don't know what they think.

      What I think is that "monetary policy" is a delusion, since it's all about fooling around with bonds and debt. Poor people won't spend more just because they can *borrow* more (at least not indefinitely), because that's dumb.

      We need *fiscal policy*, which changes people's *wealth*.

  3. Low returns make a difficult situation for retirees, however, low interest rates actually raise total returns of the economy in a situation of high unemployment so raising rates would hurt the stock market and business returns more than it would help bond returns.

    This means higher interest rates would be a loss not just for unemployed or underemployed workers but for the average saver too. The only people who would gain and get the equivalent of a subsidy would be the minority that keeps all its savings in cash and bonds.

  4. this seems rather odd. there are always fractions of the population distribution disadvantaged by any given set of policies. How big are your estimates of this "ready for retirement but constrained by nominal interest rates" fraction? Surely, Plosser and Rajan have stated why they think this fraction should dominate policy rather than other groups who might benefit from lower interest rates? (ok I doubt they did, but do you have any estimates?)

  5. "How big are your estimates of this "ready for retirement but constrained by nominal interest rates" fraction?"

    IN the united states this is the huge cohort of Baby boomers retiring ( or not as the case may be) over the next 15-20 years. The is the same group that wil be at the heart of any pensions crisis. And they're ill-equipped financially and chronologicaly to invest in speculative ventures like startups and their own businesses.

    Kinda hard to start your own business when there is abysmal demand or you're 70.

  6. I note that the various luminaries mentioned are more or less in agreement on QE. They acknowledge we've little ideas of what it does in practice (if anything. Several Fed (Fed!) studies seem to suggest a very 'modest' result in terms of real activity).

    They're just less sure whether this means it should be stopped, pursued, whatever.

    Wrt fiscal policies, we have the two usual sides - Plosser cries about 'uncertainty' in true conservative/Republican fashion, Krugman calls yet again for greater fiscal stimulus and Rajan does what he does best: Blame workers for not self-educating more... For a take down of that last bit, see:

    Honestly, I don't think Raghu Rajan really appreciates the true level of AD cratering. He says he does but the logical conclusion of that - state intervention - irks him too much so he looks for scape-goats...

  7. Anonymous5:23 AM

    Bernanke made it clear years ago that what the Fed was capable of doing was only a part of the appropriate response to our troubles. Fiscal policy in the U.S. has been, let us say, inappropriate to fostering a more vibrant recovery. Instead we have demented amateurs focused on solving problems a decade or decades away and letting the social consequences of sustained high unemployment and the consequential youthful underemployment fester and rot. I don't blame the Fed for not solving all our problems; I give it enormous credit for at least doing its fair share.

  8. Carola: I think there is a much larger context to this post. The conventional tools available to monetary authorities are limited, a point on which everyone quoted seems to agree.

    Regarding Plosser: The quote you use, albeit standard of most his public comments, doesn't really say anything. He diverts the monetary discussion by asserting the need for some certainty to be reached on fiscal policy. I've yet to hear him take a position on the "appropriate" course of fiscal policy. More specifically, the fiscal policies that would lead to the return of "confidence" and allow monetary policy to work without being obscured by fiscal concerns.

    Regarding Krugman: Krugman's position has been very clear for several years. Short term stimulus, with debt reduction to begin in the mid to longer term. Allowing for the possibility that taxes may need to rise to accommodate the debt reduction but that such taxes should be levied at a point when the economy is healthy enough to handle the burden. Unconventional monetary policy has always been a "break the glass" decision because Congressional dysfunction has made fiscal stimulus impossible. Thus, the Fed is the only body capable of acting in a stimulative capacity.

    Ideally, fiscal policy with a specific target to increase employment should address both problems simultaneously. When market demand returns, the incentives for borrowing and expansion change. Employing consumers provides wages, some of which will go to increased demand and some to their own debt payments. However, increased demand creates immediate investment opportunity for current savers - offering them better returns in the short and midterms could also preventing the trap of "reaching for yield" by allowing investment to flow into the kinds of current projects John Aziz outlines in the post. Wouldn't the expected result be overall economic improvement including a rise in interest rates which should reduce investment distortions by moving the Fed away from the ZLB, including the ancillary benefit of reducing the likelihood that savers would feel the need to "reach for yield"?

  9. I suspect that the problem here is that the obvious solution was dismissed out of hand for political reasons, as it was in Japan - that is, reckoning or, as its critics would have it, liquidation. Unfortunately Mellon gave this course of action a bad name by advocating the liquidation of even performing assets, and it tends to be advocated nowadays by right wing Austrian nutters, but the process surely does not have to be like that. What I have in mind is rigorous valuation, followed by triage and recapitalisation or sale or liquidation in the worse case scenario, with government expenditure directed towards boosting the capacity of the bankruptcy process and on transition grants to help the losers adjust. That way, a return to realistic asset prices and capacity would present a range of (even positive) return projects, removing the motive for low (even negative) interest rates.

    1. Diego Espinosa10:50 AM



      "Liquidationist" is an easy push back against the argument for structural adjustment. If the problem is returns in the economy are too low, there are two options: 1) lower the hurdle rate; 2) improve the returns. Unfortunately, when everything is a "temporary AD shortfall", the second option is not on the table.

  10. Anonymous8:52 AM

    The consensus seems to be that the central bankers are out of Shlitz and that further effective solutions are on the fiscal side. The problem is that the fiscal side is dysfunctional and like to remain so.

    This nearing-retirement saver does feel the need to save even more due to low returns and greater uncertainty. I refuse, however, to reach for yield by lending to organizations and individuals that already owe too much. I refuse, as well, to accept the insulting low interest rates on offer. Instead, I am stuffing safe deposit boxes with $100 bills and waiting for the reckoning.

    Call me crazy......

    1. Bill Ellis5:50 PM

      "The problem is that the fiscal side is dysfunctional and like to remain so."

      Monetarist love this argument...But the criticism is just as true of the monetary side.

      The QE's were way tamer than what the advocates of QE wanted. The Fed stubbornly ignores the full employment part of their mandate, and treats their inflation target like It would be a sin to actually reach it. If it came in even a bit high we would see certain, swift and harsh reaction.
      We are mired in stagnation with no inflation in sight and the Fed is about to start tapering...

      Talk about dysfunctional.

  11. I am a actual, real-live, near retirement saver who has lots of money saved. When the recession started I spent money like a drunken sailor. Part of it was because it was a good time to spend (it was impossible to get contractors to bid on things during the housing bubble). Also, I figured it was my civic duty as a saver to spend counter-cyclically. Finally, I naively assumed the recession would be short lived because policymakers would do whatever it took to fix the economy. However, after a couple years of spending freely it became clear that the government was not going follow my lead and boost spending to help the economy recover, and instead was going to "pivot" to deficit reduction, and therefore economic growth, employment, and interest rates would remain weak for the foreseeable future. At that point I shifted gears to saving more, and spending less, than ever before, because I realized that government policymakers (1) were not committed to maintaining a strong economy, and (2) were pursuing deficit reduction by cutting social security and medicare. With the government not committed to maintaining a strong job market, and with it looking to cut the social safety net it made sense to cut my current consumption to the bone to boost my financial cushion to cover future risks of unemployment and reduced social security and medicare benefits. Where is the discussion of people like me? I can't be the only one who hears talk of social security and medicare cuts and figures they have to save more to compensate. I can't be the only one who sees government indifference to persistent high unemployment and who boosts their savings in response to the higher risk of long term unemployment among people in their fifties. In a country where the vast majority of people will be entirely dependent on social security and medicare in retirement, and who will have little or no tax burden in retirement, changes to expectations about future safety net payments will have a much bigger impact on spending and saving than changes to expectations about future deficits and taxes.

    1. Anonymous11:23 AM

      The talk about QE, the Fed, and everything else without acknowledging fraud and misaligned incentives like ignoring the elephant in the room.
      Name one banker or shadow financial member who lost money, was prosecuted, or convicted. REALLY, what rich person in finance lost money??????
      Capitalism (in theory) is about investing money. We have people who empirically and indisputably lost money, and lots and lots of it....but the Fed's action is SOLELY to keep these assets they "invested" in afloat. (oh yeah, it would be so, so much worse if we didn't save the banks...JUST AS THEY are, with the same bonuses, and the freedom to do as they please. There is a collapse at the bottom, but it can only be cured by giving those at the top more money...)

      If the Fed (the Fed is SUPPOSE to regulate banks) were the were the London police of the 1890's, they would be dealing with Jack the Ripper, not by trying to catch him, (he performs the valuable discouragement of easy virtue, analogous to the "loss" part of the theoretical profit and loss) but by giving prostitutes armor. It never occurs to the London Fed police that Jack can slip a dagger through the eyeholes of the armor...

      So tell me Andyfrom Tucson, do you believe we are in a low inflation environment? (funny, when your old and actually have to buy medical care, with higher deductables, higher medicine prices, higher fees for less service, etcetera, a low priced ipad don't mean much...)

    2. Anonymous1:08 PM

      Thanks, AndyfromTucson, for writing exactly what I would write had I the time. I'm in the same situation, and thinking and behaving the same way.

    3. Nathanael3:23 PM

      I had a similar reaction, except that my "spending like a drunken sailor" was actually investing in things which mean I spend less later (like insulation, etc.)

  12. Anonymous11:54 AM

    Low interest rates shook our money tree. We used some of our "dead" money and bought a couple more rentals and did deferred maintenance on our other rentals.
    Seems some big money folks did or are still doing the rental buy.
    Are we helping?

    1. No, not helping really, especially when you buy (as opposed to doing necessary maintenance of) rentals (which I assume is American for rented housing?). That is the whole point of monetary easing. The Fed has (by risking taxpayers money) distorted the return on money-denominated assets (eg time deposits) to coerce you into supporting the value of risky assets such as housing, rather than allowing it to fall to a clearing level in an undistorted market. If you ask me, that is how the Fed contributed to the financial crisis in the first place:

  13. Anonymous12:14 PM

    I do think that Granny should be able to safeguard her slice of the pie as fraction, but I can see no argument for having an economic system that guarantees the absolute size of her slice without regard to the size of the pie

    1. Why not? If there are contracts that allow her to do that, and willing sellers of such contracts, I see no problem.

    2. Bill Ellis6:04 PM

      I agree that proportionality is a key. That is... if the social contract is still concerned with letting people retire after a lifetime of hard work and playing by the rules..(as it should be IMO .)

    3. Right now, Granny is getting way too little of the pie, because despite huge growth in the pie, incomes have been stagnant. We should simply double Social Security benefits (and the minimum wage and the peak marginal tax rate).

  14. One thing to keep in mind is that savers don't exist separate from investors and borrowers. That is, saving is equal to investment plus borrowing.

    We are in an unusual situation of post-credit-bubble reflation. Private borrowing was unusually high in 2004-2007 and public borrowing was unusually high in 2008-2012. Investment didn't increase: all that extra borrowing was also additional savings, some but not all of it foreign.

    When you're thinking about how policy impacts savers, remember that policy in a sense actually creates savers.

  15. Low interest rates do not stimulate the economy. The irrational market thinks they do, which is partly why the market is described as irrational.

    The brilliant economist Stephanie Kelton ( will tell you that low interest rates are deflationary because they starve the economy of interest payments from the federal government, aka fiscal stimulus.

  16. Anyone who is looking at J Random Net Worth Less Than Fifty or Maybe One Hundred Million and calling him or her as saver is looking at the rounding error in this game. The savers are the handful of extremely wealthy individuals and government chartered collectives who have been extracting trillions from the economy, including nearly ALL of the economic growth over the past 30 years. Low interest rates aren't going to force them to spend. They already have everything they might ever want, including Congress.

    1. Anonymous11:05 PM

      Yes, low interest rates will force them to save............but it is really about the usury rate. The flat yield was a sign of tightness of money. Now the usury rate is rising from the policy rate. That is a sign the worm may have turned without a bit of fiscal help.

  17. Anonymous11:02 PM

    The "policy" rate means nothing. The usury rate is more important.

    Low interest rates my backside. It is all real local interest rates. They zoomed up during the crisis and are still a bit high.

    When the yield curve steepens, that is a sign money is returning to the economy. Little surprise when the ARRA ran out in 2011 essentially, the yield curve squeezed together which helped the savers. Looks like money supply is starting to grow again. The flow has now entered production reports and will soon enter the government data machine in whole. The lag is evident.