Everyone Should Raise Rates, Starting With the Fed
Bank of England Governor Mark Carney says easier monetary policy may be needed to help a slowing economy in the wake of the U.K.’s vote to leave the European Union. This response is straight from the handbook of modern central banking -- a favorite with the Federal Reserve, the Bank of Japan and just about every other central bank. But it might be the wrong reaction.
I argued last month that ever-lower interest rates might be destroying whatever faith that businesses and consumers have left in the economic outlook. Cheap money keeps zombie companies alive, trapping capital in unproductive endeavors that would otherwise die. And negative interest rates are unprecedented, and look a lot like allowing doctors to experiment on their patients. The feedback I got suggested another compelling reason that higher rates might be a better approach -- demographics.
Here’s a chart showing the change in the balance of the global population between old and young:
The over-65s account for almost 9 percent of the total, a figure that’s been rising steadily and has doubled since the start of the last decade. For the euro region, this cohort accounts for closer to 18 percent; in the U.S., more than 15 percent of the population is past standard retirement age, up from 12.5 percent a decade ago.
Retirement-age people have not only increased in number, the argument goes, they also have accumulated wealth, having lived during the halcyon days of luxuries such as affordable housing and defined-benefit pensions. And they have a propensity to spend the income they get from those savings.
But with interest rates close to zero, there is no income to spend. Moreover, they're too smart to touch the capital in their nest eggs. So the more central banks drive down interest rates, the less discretionary spending the oldies can afford. Instead of spurring investment and demand, loose monetary policy may be killing consumption by punishing baby boomers.
Those lower-for-longer policies aren’t just erasing the savings rates on cash in the bank. Retirees are getting killed if they have followed the standard advice of financial advisers and moved their pensions to the supposed safety of fixed-income funds and out of equity funds. The 10-year U.S. Treasury yields just 1.4 percent, down from 2.4 percent a year ago and compared with an average in the last decade of 4.3 percent. In the 1990s, these securities had returns of more than 8.5 percent. In short, lower bond yields mean fewer cruises and Winnebagos -- bad news for the economy.
Those approaching retirement are also likely to be influenced by low interest rates. Even if they haven't done the math on how much they’ll need to spend their days on the golf course, they probably sense that they must save more, not less, which, in turn, further reduces discretionary spending. Indeed, even with interest rates at record lows, the U.S. savings rate as a percentage of disposable income is above its long-term average, and reached 6 percent at the end of the first quarter, its highest since the end of 2012:
Drew Matus, the deputy chief U.S. economist at UBS in New York, e-mailed me to point out an argument he made in April 2015 that appears to be coming true:
Having too low of an interest rate can be as disruptive to growth as can a rate that is too high. Theory would suggest lower rates will boost the economy, driving consumption and investment higher. That hasn’t happened in the post-crisis environment. Savings rates have risen and investment has been weak. Zero rates could be part of the problem rather than the solution: low rates could boost savings and inhibit investment decision-making by companies, reducing capital spending.
As my fellow Bloomberg View columnist Narayana Kocherlakota pointed out, the older generation has little incentive to support infrastructure spending on projects that typically take years to deliver any benefit to the economy. So the gray vote is unlikely to join the clamor for fiscal stimulus. But if central banks took the leap and raised interest rates, they’d be giving savers a pay increase.
The idea that raising interest rates might in turn boost consumption and lead to faster inflation is called Neo-Fisherism by economists. There’s no question that it’s counterintuitive. In that theoretical handbook of modern central banking I referred to at the start of this article, it would be deep in the “Unconventional Policies” chapter. But as interest rates are negative and European Parliament members are petitioning the European Central Bank to consider dropping helicopter money onto the economy, the suggestion that interest rates need to rise to rescue the economy may not be so outrageous after all.
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