It gets worse. Not only have very low or negative interest rates failed to stimulate demand, they have arguably reduced demand as people save more and spend less.
Why do people do this? Imagine you’re a retiree trying to live off the interest on your savings. In order to get any income at all, you’ve had to take on more risk by holding long-maturity bonds, junk bonds, preferred stocks, etc. You compensate for this risk by giving yourself a bigger savings cushion. That means you have to reduce spending somewhere else.
Do central bankers not see this? They can surely read the same studies I do. In any case, the financial industry is waking up to the fact that something is very wrong.
Last week the Financial Times had an excellent column by Eric Lonergan, a macro fund manager at M&G Investments and proprietor of PhilosophyofMoney.net. He quickly and eloquently dismantled the foundation of modern central banking.
The idea that lower interest rates raise demand is based on the view that households attempt to smooth their consumption over time. This assumed relationship has little empirical support, and there are good reasons, particularly when rates are extremely low or negative, to doubt it. High existing debt levels, or poor creditworthiness, are more realistic constraints on spending than higher interest rates.
And what of savers? Lower rates have a depressing effect on household incomes, through reduced interest on savings and pensions. It is likely that in relatively wealthy economies – with rising healthcare costs, increasing longevity and uncertainty over pension funding – households respond to lower income on their savings by trying to save more. If this outweighs the reduced incentive to save, the actions of central banks are self-defeating. The relationship of spending to lower interest rates may well be the reverse of that assumed by policymakers. If consumers do not respond to lower rates by spending more, this places an additional onus on the corporate sector.
Yet corporate investment appears similarly unresponsive. Investment decisions have financial consequences over many years, and are more influenced by beliefs about future growth and attitudes to risk than by overnight interest rates set by central banks.
Indeed, cash hoarding is exactly what we see corporations doing, or at least those corporations that can make a profit in this environment. Apple, Microsoft, and all the other US tech giants have billions stashed outside the country for tax reasons. But they would still keep much of that money in cash even if the tax disadvantage went away. They have no need to spend it, very little to invest in, and see no reason to risk losing it or to bring it back into the United States to pay high corporate taxes. So there it sits, not stimulating anything.
As for consumers, I think Lonergan explained it well: “High existing debt levels, or poor creditworthiness, are more realistic constraints on spending than higher interest rates.” Most Americans have excessive debt, low credit ratings, or both. Low or even negative interest rates will not make them spend more money as long as that is the case.