A mixed blessing

Central banks almost everywhere, the Bank of Canada, the U.S. Reserve, the European Central Bank, and the Bank of Japan all have slashed interest rates to almost zero.

The effects present a very mixed picture.

Typically, of course, low interest rates are a prop to the economy; they reduce the cost of capital, leading to more investment.

Households are encouraged to spend then, for example, purchasing a house because mortgage payments become more affordable, or perhaps buying a new car now as so often low interest loans are available for five years.

Low interest rates lead to higher stock prices, so the wealth effect makes people feel more prosperous and more likely to indulge in spending. Households are encouraged to consume now rather than later.

Furthermore, low interest rates move income from creditors to debtors, who, it is assumed, will spend the ensuing windfall.

Critics argue that there is another side to this issue. Businesses and households cannot borrow, presumably as banks or others are unwilling or unable to lend money in view of the small returns on loans. Then too, lower rates cost households huge sums because of foregone income. The creditors have no choice except to consume less.

Households own huge sums on certificates of deposit, bonds and others interest-bearing instruments. As income falls drastically on them primarily for older, wealthy individuals, this may be partially offset as others (debtors) gain.

Funds must be set aside to generate the pension benefit promised to employees. As is the situation with bonds, the cost of promised benefit climbs as interest rates decline, even factoring in the likely rise in most common stock prices. The ensuing deficits must be closed over the period that the pensions ordain.

Irresponsible investors/speculators indulge in tactics that are fraught with possible dangers. Funds may be placed in low-grade obligations where defaults are more likely to ensue, all in efforts to earn more interest.

Middle income families will lack a buffer to make up for lost income from their interest-bearing instruments.

Perhaps low interest rates entail a more growth-oriented trajectory, but other considerations make this case compelling.


Bruce Whitestone