Since the 2006–07 financial crisis the Federal Reserve has taken several steps to stimulate the economy and unfreeze credit markets, which had ground to a halt after the bursting of the housing bubble. The Federal Reserve launched its current monetary strategy in 2007, lowering the federal funds rate from 5.25 percent to effectively zero by the end of 2008. It has remained near-zero ever since, and the Fed has shown no inclination to increase the rate.
The theory behind the zero interest rate policy (ZIRP) is that low interest rates stimulate investment while allowing consumers and businesses to finance large purchases more easily, resulting in more products and services being produced and lower unemployment. Low interest rates are also said to lessen the federal debt burden and encourage banks to lend and invest their money because the rate of return makes holding it less profitable.
A ZIRP has significant consequences, however. A long-term ZIRP erodes the value of savings and investments, creating what can best be described as a hidden tax, with investors paying for the cheap money to banks with the diminished value of their savings accounts. The influx of new dollars into the money supply has devalued the existing currency already in the economy, reducing the value of all savings and retirement accounts.
The result of this devaluation of savings is to push investors into higher-risk areas such as the stock market. This may spur the economy in the short run, but it is likely to lead to stock bubbles that will crash people’s retirement plans.
Another damaging element of the ZIRP is the interest payments the Fed is sending banks for money held in reserve. By stopping those payments, the Fed could increase lending by removing this artificial incentive to hold cash in reserve, critics argue.
The Federal Reserve’s ZIRP has done little to stimulate the economy and has done much to hurt investment and savings. The Fed should implement new policies that promote a strong dollar and interest rates based less on manipulation and more on market forces.
The following articles examine zero interest rate policy from multiple perspectives.
Zero Interest Rate Policy Is Batting Zero
David Ranson of Forbes discusses the zero interest rate policy, explaining how it has been used in the past and documenting its record of failure. “A check of long-term historical relationships shows that the growth of bank reserves is related inversely to economic and stock market performance. Far from the ‘nuclear option’ originally advertised, ZIRP, we have learned, is more of an economic drag than a boost,” he writes.
The Downside of the Fed’s Zero Interest Rate Policy
David Shulman, senior economist at the UCLA Anderson Forecast, argues the Federal Reserve’s current interest rate policy is enabling the poor spending and budgeting habits of legislators and ought to stop: “Thus it might help if the Fed ceased enabling the politicians to continue on their reckless ways. So instead of contemplating a new round of quantitative easing, the Fed instead, should be thinking about returning to a more normalized interest rate policy.”
The Efficacy of the FOMC’s Zero Interest Rate Policy
Daniel L. Thornton, vice president and economic advisor for the Federal Reserve Bank of St. Louis, writes in this Federal Reserve Economic Research document that the Fed’s zero interest rate policy may not be effective and in fact may hinder economic growth. “If investment spending is sufficiently insensitive to interest rate changes and the effect of Fed actions on interest rates is sufficiently weak, the net effect of the persistent zero interest rate policy could be negative,” he writes.
The Pain of Zero Interest Rates
John H. Makin of the American Enterprise Institute argues that while the zero interest rate policy is harming both borrowers and retirement plans, the low rates are necessary because the economy needs the Fed’s “easy-money drug.” He writes, “Like it or not, the economy and financial markets need the easy money drug for now. It can be withdrawn slowly only once the ailing economy is on the mend—perhaps in 2014.”
Zero-Interest Rate Policy and Unintended Consequences in Emerging Markets
Andreas Hoffmann of the University of Leipzig describes the unintended consequences of the low interest rate policies in emerging markets. Based on the Mises-Hayek business cycle theory, Hoffmann contends the current low interest rate policy in advanced economies may have planted the seeds for new bubbles and given impetus to interventionism in emerging markets.
The Problem with the Fed’s Zero Rate Policy
In testimony before the Senate Banking Committee’s Subcommittee on Economic Policy, Jim Rickards identifies the effects of the Federal Reserve’s zero interest rate policy and explains how it has benefited banks and hurt prudent savers and investors.
Why Are Interest Rates Being Kept at a Low Level?
The Federal Reserve explains its rationale for its current low interest rate policy is this Q&A. A video explaining the effect of low interest rates on savers is included.
The Financial Turmoil of 2007-XX: Sinners and Their Sins
George Kaufman identifies the main culprits or sinners and the major sins they committed in the financial crisis that started in the summer of 2007. Interest rate policy is among the issues discussed.
Federal Government Rapidly Expropriating Nation’s Wealth
Robert Higgs of the Independent Institute argues that under the Federal Reserve’s current low interest rate policy the government has committed a vast expropriation of private wealth. “Entire classes of investors—especially people who saved during their working years and expected to live on interest earnings on their accumulated capital during their retirement years—are being steadily wiped out,” Higgs writes.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartlander’s Finance and Insurance News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or [email protected]