Reports are that the Federal Reserve may decide to start cutting back on its quantitative easing program, i.e., its $85 billion-per-month bond-buying program, as early as its meeting today and tomorrow. However, even if it does that, it appears that the Fed will continue its program of near-0% short-term interest rates for some time to come.
The United States has had near-0% short-term interest rates for five years now. While there have been some complaints, it has been pretty much ho-hum (other than some concerns about inflation). The reaction in Germany to similar rates, however, has been quite different. On November 7, the European Central Bank lowered its base interest rate from 0.50% to 0.25%, and there were lots of objections. This is from SpiegelOnline on November 8:
“Axel Kleinlein, the head of Germany's Association of Insured Persons (BDV), told the Berlin daily Der Tagesspiegel that the lowered interest rate could dash hopes of the German people for decent pensions. He said it is precisely those who are saving up for old age who will be punished.
Meanwhile, the German Insurance Association (GDV), an umbrella group of private insurers in the country, said the interest rate decrease sent a ‘fatal message’ to all people saving for old age in Germany. ‘The lower interest rate will be a major burden to them,’ said association head Jörg von Fürstenwerth.”
Here’s more from SpiegelOnline on November 20:
“But the reverberations of the Frankfurt bombshell are still audible today. … Now it is becoming apparent that savers will have to endure even more pain … .
The tense climate in the ECB Governing Council dovetails with the grim mood among German savers. The inflation rate is already higher than the rate of return on many investment products. …
Only a few years ago, Germans were convinced that they could offset the cuts lawmakers had made to government-mandated pensions by saving more money on their own. …
‘In Germany today, people can no longer provide for their retirement by saving,’ says Walter Krämer.”
The purpose of the low interest rates is to get the economy growing. The idea is that the low interest rates will encourage companies to borrow. They will use the money to expand or buy more equipment. Employment will increase, etc. Similarly, if interest rates are low, consumers will increase spending on interest-sensitive purchases, like cars and other consumer durables. As consumers spend more, businesses will expand, which will cause employment to increase.
The problem is it doesn’t seem to be working. The Wall Street Journal had a long article on November 18, 2013, about Japan’s efforts to increase borrowing by business. Like the United States, Japan has not only lowered interest rates but also implemented a quantitative easing program. However, in spite of low interest rates and lots of money being available, Japanese companies aren’t borrowing.
In the United States, the growth that was supposed to come from low interest rates hasn’t happened. Why? First, there is more to borrowing, and growth, than just low interest rates. It doesn’t matter how low interest rates are; people aren’t going to borrow if they don’t have some degree of confidence about the future of the economy and their business.*
Consider: At the same time the Fed is keeping short-term interest rates near 0%, the Obama administration is loading up businesses with new regulations and costs – and proposals for even more. For example, at this point who knows what is going to happen with the Affordable Care Act and how much it is going to cost? In addition, President Obama has called for an increase in the minimum wage, and Democrats want to reauthorize extended unemployment benefits, which will ultimately result in more taxes on companies. The Labor Department is changing overtime rules for healthcare workers. The Environmental Protection Agency is going after coal. The National Labor Relations Board is going after employers.
I understand that Democrats/progressives think these are good things, but you wonder if anybody in the Administration is considering how these ideas might be affecting the people who actually create new jobs and hire new workers.**
Instead of making it more expensive to hire people, we should be making it easier to hire people. I am sure many in the Administration would interpret this as a call for more government programs and more tax subsidies, but that is not what I am suggesting. Instead of government getting more involved, government should get less involved. Instead of doing more, government should get out of the way – and get the rules and regulations out of the way, too. Cut costs on hiring; don’t raise them. Reduce the complexity of government regulation; don’t add to them. And do it permanently; not just for a year or two.
(These are the kind of ideas are usually suggested for more regulated economies, such as labor markets in Europe. The fact that they should now be suggested for the United States {appropriately, I might add}, tells you how much things have changed in the United States in recent years.)
Second, maybe cutting interest rates doesn’t work like it used to. Short-term interest rates have been near 0% for five years now, and they haven’t done what their supporters have said they would do. If we ask the proponents of this policy why it hasn’t worked, I am sure they would say that, even though the policy has not worked as well as they predicted, things would have been worse now if we hadn’t kept interest rates near 0%. They would also say that things would get worse if we don’t continue to keep interest rates where they are. The trouble is, when they tell us that, they use the same models and reasoning that they previously used to tell us what near-0% interest rates were going to accomplish. Except the policy didn’t do it. Maybe things have changed such that we need a new theory/model.
Tied in with this, given that near-0% interest rates haven’t worked like they were supposed to, maybe it’s time to look again at the balance of the costs and benefits of the near-0% interest rate policies – because clearly there are costs. People who invest in stocks may have more income to spend because of these policies, but people who put their money in savings accounts and other fixed income investments have less income to spend (as well as seeing their principle go down {after taking into account inflation}).
Fed Chairman Ben Bernanke has said that these costs were worth it because we would all be better off when the economy grew. But the economy hasn’t grown as he predicted it would. The benefits have not been as great as they were supposed to be. Now that we have a better idea of the actual benefits of these policies, as well as the actual costs, it seems appropriate to re-calculate the cost-benefit analysis of the Fed’s near-0% short-term interest rates. We might find the answer is different than we previously thought.
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* The Economist recently reported on research that shows “when uncertainty is high, companies’ response to policy stimulus tends to be muted.” (“Free Exchange: Holding on for tomorrow,” The Economist, November 16, 2013.)
** With respect to some of the policies the Administration has suggested lately, let me note a couple of responses. In last Saturday’s Wall Street Journal, Martin Feldstein suggested, instead of raising the minimum wage, “[a] better approach would be to integrate the existing minimum wage with current welfare transfer payments. … [T]he goal should be to raise incomes while increasing job opportunities for those whose skills are too limited to find work at the minimum wage.”
With respect extending period of unemployment compensation payments, a recent working paper published by the National Bureau of Economic Research, came to this conclusion: “Our estimates imply that most of the persistent increase in unemployment during the Great Recession can be accounted for by the unprecedented extensions of unemployment benefit eligibility.” (Marcus Hagedorn, Fatih Karahan, Iourii Manovskii, and Kurt Mitman, “Unemployment Benefits and Unemployment in the Great Recession: The Role of Macro Effects,” Working Paper 19499, http://www.nber.org/papers/w19499.)
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