Fed confirms policy on interest rates

The Federal Reserve Board concluded its September meeting on Wednesday. The

Fed confirmed that it expects to maintain its zero-interest-rate policy at least until the end of 2023.

This represents a renewed round of capital punishment for savers. The last episode of the zero-interest policy lasted from 2008 to 2015. At least savers back then could move from CDs to longer-term bonds and pick up some interest income. For example, the 10-year Treasury bond was yielding 2.1 % in 2015 compared to 0.7% today.

In theory, low interest rates boost the economy in two ways. First, low interest rates make purchases with borrowed money more affordable. Everything else being equal, borrowers can more easily purchase everything from a house to a car to a college education more easily when interest rates are low.

These purchases keep professors, carpenters and auto workers busy. They, in turn, have money to spend which keeps stores and restaurants open which leads to jobs for cashiers and clerks and so on and so forth.

Low interest rates also increase asset prices. Stock prices are generally higher when interest rates are lower and vice versa. Home prices are higher — of course this negates the lower interest expense — but who’s counting. Those who own stocks or houses feel richer and this wealth effect supposedly induces them to go on a spending spree.

Do the theoretical benefits of the zero-interestrate policy match the reality?

The economic recovery from the 2008 recession was one of the slowest on record. As it turns out, borrowers were less inclined to take on new debt than they were to pay off old debt. Meanwhile, savers who relied on interest income suddenly had less money to spend.

What about the wealth effect?

The zero-interest-rate policy is highly effective for increasing asset prices. As interest rates fall, stock prices and housing prices generally rise. In real estate, the monthly payment on a 30-year $300,000 loan at 4% is the same as the becomes the monthly payment on a $340,000 at 3%. In the financial markets, TINA — there is no alternative — becomes the rule of the day as investors are forced to buy stocks if they hope for any kind of return on their money.

Whether this newfound wealth gets spent is a different question entirely. Evidence on this score is weak.

Whatever effects zerointerest-rate policy has on the economy as a whole, there is one clear winner. That winner is the U.S. government.

Back in 2007 when interest rates were “normal,” the U.S. had a cumulative deficit of $9 trillion and paid $237 billion in interest.

In 2019, the U.S. had a cumulative debt of $22.7 trillion and paid $375 billion in interest.

This is the largest cash-out re-fi history. The federal government borrowed $14 trillion while paying only $140 billion in additional interest.

Going forward, every 1% increase in interest rates will cost the federal government $230 billion per year and that’s before the COVID-19 deficit explosion.

Someday, it’s going to get ugly.