A low Fed rate: what does it mean for the 99%?
I’m no economist, so it always takes me quite a bit of puzzling to figure out macro-economic arguments. Recently I’ve been wondering about the Fed’s promise to keep rates low for extended periods of time. Specifically, I’ve been wondering this: whom does that benefit?
[As an aside, it consistently pisses me off that the people trading in the market, who claim to be all about “free markets” and against “interference” from regulators, also are the ones who whine for a Fed intervention or quantitative easing when bad economic data comes out. So which is it, do you want freedom or do you want a babysitter?]
Here’s the argument I’ve gleaned from the St. Louis Fed’s webpage. When the Fed lowers (short-term) rates, it makes it easier to borrow money, it makes it easier for banks to profit from the difference between long-term and short-term rates, and it potentially can cause inflation (and bubbles) since, now that everyone has borrowed more, there’s more demand, which raises prices. And inflation is good for debtors, because over time their debts are worth less.
One thing about the above argument stands out as false to me, at least for the majority of the 99%. Namely, many of them are already indebted up their eyeballs, so who is going to give them more money? And what would they buy with that money?
In other words, if the assumption is that everyone is getting easy loans, I haven’t seen evidence of this. Wouldn’t we be hearing about people refinancing their homes for awesome rates and thereby avoiding foreclosure? How many stories have you heard like that?
If not everyone is getting easy loans, and if in fact only the 1% and banks are getting those gorgeously low-interest loans, then it’s not clear this will be sufficient to spur demand and cause inflation. And inflation really would help the 99%, but only of course if wages kept up with it. Instead we have not seen high inflation and wages haven’t even been keeping up with what inflation we do see.
So let’s re-examine who is benefiting from low Fed rates. I’m gonna guess it’s mostly the banks, and a few private equity firms that are borrowing tons of money to buy up great swaths of foreclosed homes so they can turn around and profit on renting them out to the people who were foreclosed on.
I’m not necessarily advocating that we raise the Fed rates. But next time I hear someone say, “low Fed rates benefit debtors” I’m going to clarify, “low Fed rates benefit banks.”
mathbabe 
That the Fed’s rate-setting intentionally favors banks and private equity firms over individuals strikes me as being nearly tautological at this point in time. What maybe best characterizes the present era is it is one of both unprecedented transparency (the web, blogs, instant global communication) and unprecedented opacity (finance, capital flows, legalized theft). The two are battling it out. Somehow despite transparency’s stunningly fast growth, opacity still has the upper hand.
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You have pinpointed exactly the problem of our current crisis. Krugman, and the MMT folks too, think the problem is that the Fed hasn’t gone far enough: more QE would not only give the desired inflation, but also lower bond yields (QE is accomplished by buying bonds), which in turn would drive the banks away from those safe harbors and incentivize more lending.
But QE also cheapens the dollar which drives investors to commodities, and that drives inflation-without-employment — that’s what created the Arab Spring: QE2 drove inflation all over the world because investors bought up commodities, including food, to get the hell out of dollars.
So the Fed may be chastened by the results of QE2.
For the record, Ron Paul blames the bubble on the Fed’s low rates. At least he’s consistent.
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So you like Operation Twist, then.
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@rob:
MMT folks do not believe that QE causes sustained inflation and don’t subscribe to the quantity theory of money:
http://bilbo.economicoutlook.net/blog/?p=661
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@whoosh — yes, sorry if I was elliptical. They think the Fed’s monetary expansion cannot go far enough because it goes to the wrong place; it’s too indirect to induce lending, the bog Cathy describes. The Fed’s means are constrained by law, and those means play to banks — but isn’t that all they’ve got to play with? MMT does see a role for fiat money through government spending directly into the economy, creating demand and jobs. But that’s not the Fed’s role.
Keister and McAndrews, independent of MMT, claimed that the Fed’s historic decision to pay interest on excess reserves explains why low interest rates did not induce lending. That again makes it seem like the Fed is coddling the banks, but it may have been just their limited means of controlling them. http://www.newyorkfed.org/newsevents/news/research/2009/rp091217.html
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Long-time lurker, first-time commenter.
I think that one must look at three things to think clearly about the effect of low interest rates.
First is the timeframe; one common effect of lowering short-term rates (which the Fed can do easily) is to steepen the yield curve. Obviously, if short-term rates are low, but long-term rates aren’t, long-term debt (like mortgages) will get more expensive relative to short-term debt (like credit cards). Anecdotally, that’s what I’m seeing; credit card offers at attractive rates seem to be pretty common, but getting mortgages is hard.
Second, closely related, is expectations: even if current long rates are low, if they aren’t expected to stay low, banks will be reluctant to lend at current long rates if they will need to fund out of deposits at current rates in the future. (This is what killed the S&L’s–lend at 6% and borrow at 10% is not a viable business model.) (Note that this problem is what mortgage-backed securities try to get around–in theory, they let current mortgages be backed by current assets, rather than future deposits; they introduce their own risks, though.)
Third is terms: lending standards have tightened dramatically (especially in mortgage and business markets), which means that low-cost mortgages are available, but only to very good buyers and properties.
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Your points aren’t wrong, but you could argue that the emphasis is mis-placed. To deal with your aside first, whether you like it or not, central banks have a legally mandated role to play in capital markets as far as setting (some) interest rates goes – and to the extent that market participants view one interest rate regime as better for their portfolios than another, they’ll argue for it – whether that’s higher or lower.
More centrally, central bankers are not trying to inflate away debts when they lower rates; in fact, most central banks are mandated to keep inflation down, and its emergence if rates were kept too low would generally be seen as a policy error. Instead, businesses can (theoretically) borrow at lower rates, which (theoretically) encourages investment which in turn (theoretically) spurs jobs and demand.
If you wanted to make a more direct argument about the impact of low interest rates on low-income groups/high debt groups, you’d point to the portion of their borrowing that’s at floating rates, and the quantum of the decline in their interest costs is effectively an increase in their disposable income. To the extent that they have fixed rate debts, there is a (theoretical) ability to refinance at lower rates – but that assumes that their collateral, capacity and credit have remained undamaged by whatever event it was that’s prompted policy-makers to keep interest rates low in the first place. Clearly, right now, that assumption is a stretch.
Finally, your last line doesn’t ring true, and I think it’s an issue of what your null/alternative hypotheses are. In a high-interest rate environment, banks can actually benefit: they pay out next to nothing on deposits, and lend at the higher rates, so their spread (net interest margin) is higher than in a low interest rate regime. Meanwhile, the highly indebted, low income groups that you’ve referenced see their carry costs increase and new debt become more expensive – it’s hard to see how higher rates are anything but bad for them. In fact, the people who are most hurt by low interest rates are probably those who have saved during their working careers and are relying on bonds for income during retirement.
I’m not suggesting that low interest rates only benefit the poor, or that low interest rates are the only tool that’s needed to help the group that you described solve its problems; I would say that low rates are better for them than high, that this isn’t true for every socio-economic group, and that policy tools other than interest rates are generally only available to policy makers other than central bankers.
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Direct transfer of cash, i.e., stimulus, gov’t programs to aid the infrastructure, a WPA type program for those of us in pursuits and bodies different than young men who can build roads. That’s what’s needed. In 2009.
To my regular citizen perspective, not a mathematician, not an economist, it was the central banker Alan Greenspan who was the Michael Jordan of our economic decline. He kept interest rates slow even when the economy was booming. If the ridiculous expansion of housing prices was not inflationary, then what the hell is inflation? Every dumb no-nothing like myself knew this was a bubble, and he, since he didn’t have any personal skin in the game, stuck hard to the bullshit mantra that a bubble is not callable while it’s happening. Like Alzheimer’s can’t be diagnosed until the autopsy of the person who dies from it.
PLUS. The Fed is the regulator of mortgage processes, and Greenspan turned his back on numerous state Attorneys General and other agencies’ desperate complaints about fraudulent and abusive lending practices.
He should be forced to stand in a circus wagon and be rolled into every town square and big box store parking lot in the country giving understandable laymen’s explanations about what he did, how this economy went bad, etc,. And I’d like to be on that tour with him and every time he obfuscates, I pull his chain and force him to explain it again and again until we all understand!
And after he finishes his tour, he can go back to the bathtub.
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Yes, economists so loved the market that they gave their only begotten brain.
throughout graduate school I could never relate to the ease that my follow students and professors accepted so much nonsense. case in point: THE (!!!) market rate of interest.
Obviously, any interest rate is part of a contract and there are literally billions of contracts that include a contractual rate of interest. One only has to consider the contracts for credit cards to know that the concept of “a market” for credit cards has nothing to do with markets as economists have modeled them. And, as noted in the recent debates over financial reform in the credit card industry, the contract contains a variable rate of interest even when it doesn’t. That is, the credit card company can change the rate of interest you agreed to because you had agreed to let it do that–didn’t you read the fine print, you peon.
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“So let’s re-examine who is benefiting from low Fed rates. I’m gonna guess it’s mostly the banks, and a few private equity firms that are borrowing tons of money to buy up great swaths of foreclosed homes so they can turn around and profit on renting them out to the people who were foreclosed on.”
A more accurate description as to who are those who “could using almost “free” money courtesy of the FED… bought “great swaths” not of foreclosed homes… but of the scarcest
and “safest” asset on the planet… U.S. Treasury Zero Coupon Treasuries…
Anyone and everyone who could buy even unleveraged US Treasury Securities…just as
Chairman Bernanke… told you.. ( I would say actually begged you.)..
Pimco’s US Treasury ETF “ZROZ”… is up around 50% over the last months… close to
20% since April… totally unlevered… and with NO management fees…
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