'Shut Up, Savers!'

James Surowiecki addresses the complaint the low interest rates are hurting people who live off their investment income:

Shut Up, Savers!, by James Surowiecki: Ben Bernanke..., according to a chorus of critics,... is one of history’s great thieves. Over the past four years, the Fed has kept interest rates near zero and has pumped money into the economy by buying trillions of dollars in mortgage-backed securities and government debt. The idea is that a so-called “loose” monetary policy can help galvanize a weak economy... But, to his detractors, Bernanke is guilty of waging a “war on savers”—fleecing people, especially retirees, of hundreds of billions of dollars that they could have earned in interest. Among many conservatives, this notion has become mainstream. ...

Certainly, it’s not the easiest time to live off interest income. ... No wonder people with lots of savings want the Fed to ... raise interest rates. But most Americans depend on wages and salaries for their livelihood, not on interest income, and higher interest rates would hurt the job market... Also, most Americans have more debt than savings, which means that they benefit directly from lower interest rates. ... Even seniors, one of the groups most obviously hurt by low interest rates, get only ten per cent of their income from interest payments. Bernanke has been accused of waging class warfare and forcing senior citizens to eat cat food, but the simple fact is that people who are net savers are, on average, wealthier than those who aren’t.

And what if the Fed did raise interest rates? It’s unlikely that savers would be better off in the long run, since the move would slow down the economy as a whole and perhaps even tip us back into recession. ... Indeed, the biggest culprit when it comes to low interest rates isn’t the Fed: it’s the weak economy... That’s why interest rates are low across most of the developed world—even in countries where central bankers haven’t been buying up assets the way the Fed has. ...

Currently, the big risk isn’t that the Fed will wait too long to raise interest rates; it’s that pressure from savers will cause it to raise them prematurely. The economy may be looking a bit perkier, but it’s still growing slowly, and it has an enormous amount of ground to make up... It may be hard for people to live off their savings these days, but the far more urgent problem is that it’s even harder for people who don’t have jobs, or whose wages are stagnant, to save anything at all.

There's another important point. Currently, as explained here by Paul Krugman, the interest rate is at the zero bound and therefore cannot fall to the level consistent with full employment. Here's his graph to illustrate this point:

What would raising interest rates do in this case? It would increase savings, but decrease investment making the imbalance (and the recession) even worse. As Krugman says:

The policy problem is that for whatever reason — in current conditions, mainly the deleveraging taking place after an era of debt complacency — the interest rate that would match savings and investment at full employment is negative. Unfortunately, that’s not possible, because rather than lend at a loss people can just hold cash. So we have an “incipient” excess supply of savings, which is eliminated not via a fall in interest rates but via a fall in income, i.e., a depression.

Now, the figure above may look familiar from microeconomics; it’s more than a bit like the standard analysis of a price floor that creates a persistent excess supply of a good, such as the way European price floors on agricultural products created butter mountains, wine lakes, etc..

One way to think about macro policy in a liquidity trap is that it’s about trying to reduce that incipient surplus, say through government spending to make use of the excess savings.

But what the people who want to raise rates are demanding is that we take the price floor that is causing this destructive surplus, and raise it higher.

Yes, savers would like higher returns, just as farmers would like higher prices for their butter. But free-market oriented economists, of all people, should understand that you can’t just decree higher returns without paying a price in economic disruption.