A Core Tenet of How Central Bank Stimulus Supports Growth Doesn't Fit the Data, According to Deutsche Bank

Lower rates actually hurt consumers.

Risk Illustrations

Savings spurred or slammed?

Photographer: Ron Antonelli/Bloomberg

Central banks the world over have reduced interest rates more than 500 times since the collapse of Lehman Brothers in 2008. But a crucial part of their thesis on how lower rates are supposed to help spur economic activity may be off the mark, according to strategists at Deutsche Bank.

Cutting interest rates in response to a deteriorating outlook is thought to work through a variety of channels to help support the economy. Lower rates are supposed to encourage households to borrow and businesses to invest, while ceteris paribus, the softening in the domestic currency that accompanies a reduction in rates also makes the country's goods and services more competitive on the global stage.

Most questions raised about the broken transmission mechanism from central bank accommodation to the real economy have centered on the efficacy of quantitative easing. But Deutsche's team, led by chief global strategist Bankim "Binky" Chadha, contends that the commonly accepted link between traditional stimulus and household spending doesn't have the net effect monetary policymakers think it does.

This assertion comes about as a byproduct of the strategists' investigation into what drives the U.S. household savings rate, which has largely been on the decline for a number of decades.

First, the strategists make the inference that the purpose of household savings is to accumulate wealth. If this holds, then it logically follows that in the event of a faster-than-expected increase in wealth, households will feel less of a need to save because they've made progress in collecting a sufficient amount of assets that allows them to enjoy their retirement, pass it down to their children, and so on.

Chadha & Co. argue that wealth is therefore the driver of the U.S. savings rate: As this rises, the savings rate tends to fall:

Deutsche Bank

"The savings rate has been very strongly negatively correlated (-86 percent) with the value of gross assets scaled by the size of the economy, i.e., the ratio of household assets to nominal GDP which we use as our proxy for wealth, over the last 65 years," wrote Chadha.

And the real interest rate, in turn, influences how quickly households are able to amass wealth:

Deutsche Bank

"Indeed, historically the part of the savings rate that is not explained by the level of wealth is strongly negatively correlated (-46 percent) with real interest rates," wrote the strategists.

Deutsche Bank posits that lower real interest rates reduce households' expected return, thereby prompting them to save more in order to meet their long-term financial goals and forgo spending today.

The team estimates that Fed policy has driven real rates in the U.S. to 2.5 percentage points below their neutral levels, which has resulted in a 0.9 percentage-point rise in the savings rate. Any increase in the savings rate entails an offsetting decrease in the consumption rate, as households refrain from spending that portion of their income, which weighs on current economic activity.

"While a number of arguments can be made for why countercyclical monetary policy in the U.S. through lower rates is supportive of economic growth, the encouragement of a lower savings rate (higher consumption rate) is not one of them," wrote the strategists. "Indeed the empirical evidence is strongly to the contrary: lower rates look to be lowering the consumption rate and lowering aggregate demand."

This quite clearly goes against economic orthodoxy on how interest rate cuts affect different segments of the economy. Chadha & Co. believe that consensus has failed to properly identify this dynamic because of a focus on the wrong side of the aggregate household ledger:

The traditional wisdom that lower interest rates encourage economic growth focuses on the debt side of the household balance sheet. Lower rates clearly have a number of positive impacts on the debt side of the balance sheet, which encourage growth. But the point is that the asset side of the balance sheet is much bigger than the liabilities side, some seven times. This fact has two important implications. First, interest income foregone by households from their cash holdings alone of around $10 trillion at current zero short rates compared to the FOMC’s median neutral rate is $360 billion (2 percent of GDP). Second, a protracted period of low rates that lowers the perceived longer run rate of return on assets, raises the savings rate.

So if real interest rates rise in the event of a continued acceleration in U.S. growth, Deutsche's framework would imply that the consumption rate would rise as American households felt more optimistic about hitting their long-term wealth targets, further supporting economic activity.

The causes of the long-term decline in the U.S. savings rate have been debated for decades by academics.

Larry Summers co-authored a paper in the late 1980s on this subject, taking a similar approach in first attempting to identify the reasons why households saved money — for retirement, unexpected medical expenses, or to finance big-ticket purchases — and factors that may have contributed to a reduction in required savings. He wrote that "improvements in the economic well-being of the elderly, improvements in public and private insurance that have reduced the need to save for 'rainy days,' and increases in the ease with which consumers can borrow" were secular forces driving the decline in the U.S. savings rate that were likely to endure.

And as Michael Pettis, professor of finance at Peking University, reminds us, savings rates aren't set in a vacuum. To a large extent, national savings rates reflect policy decisions that are made around the globe, not moral or cultural inputs. If, for instance, the world were composed of just two countries — the U.S. and China — both national savings rates cannot be positive; the cumulative public, corporate, and household savings rates must net to zero.

"... [D]istortions in the savings rates in one part of the global economy can, in a fairly automatic way, work themselves into the rest of the world through the current and capital accounts," wrote Pettis in The Great Rebalancing.

Nonetheless, Deutsche's team offers an interesting micro-based view for why global central bankers' attempts to boost their economies may not have worked the way they intended — and why a prophesied rise in real interest rates may be yet another tailwind for the already buoyant U.S. consumer.

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