Fed Official Says Fed's Interest Rate Policy May Hurt the Economy

NEW YORK (MainStreet) – Acknowledging the danger of a near-zero interest rate policy, one Federal Reserve bigwig says that it’s a policy that may be becoming “counterproductive.”

James Bullard, the chief executive officer of the Federal Reserve Bank of St. Louis, says it could be a long time before interest rates get off the floor, and that could hurt the economy – and especially older bank savers.

There’s no doubt that bank rates are at historic lows. Here’s a snapshot of some key bank interest rates, as measured by BankingMyWay’s National Money Market, Savings and Interest rate Checking calculator:

Interest Checking
Interest rate: 0.071%
Date: 2/9/2012

Money Market
Interest rate: 0.157%
Date: 2/9/2012

Savings
Interest rate: 0.112%   
Date: 2/9/2012

In a Feb. 6, 2012 speech to the Union League Club of Chicago, Bullard said a policy of short-term low rates that lead to the level of bank rates listed above is understandable – even preferable – but a policy of long-term low interest rates could be downright harmful.

“If we were proposing to remain near-zero for a few quarters, or even a year or two, one might argue that such a policy matches up well with the short-term business cycle dynamics of the U.S. economy,” he said. “But a near-zero rate policy stretching over many years can begin to distort fundamental decision-making in the economy in ways that may be destructive to longer-run economic growth.”

Bullard seemed particularly concerned about older bank savers, who comprise the majority of certificate of deposit, money market, and interest and savings account savers in the U.S., as a continued policy of low-interest rates is really beginning to eat into their budgets since the money can't even keep up with inflation.

“In particular, the lengthy near-zero rate policy punishes savers in the economy,” Bullard explained. “Because of life cycle effects, most of the asset holding in the economy is done by older Americans. Recent readings from the TIPS market suggest a 10-year real rate of return of minus 30 basis points or so, and a five-year real rate of return of about minus 120 basis points.”

Low rates aren’t only hurting older Americans – they’re impacting the younger generation as well.

“In principle, the low real interest rates should encourage younger generations to borrow against their future income prospects and consume more today,” Bullard says. “However, this demographic group faces high unemployment rates and tighter borrowing constraints, which may limit its ability and willingness to leverage up to finance consumption.”

Bullard explained that this scenario may not work out well for either demographic in the end.

“Consequently, the consumption of the older generations may be damaged by the low real interest rates without any countervailing increase in consumption by other households in the economy,” he says. “In this sense, the policy could be counterproductive.”

Bullard took pains to say that the scenario he described in Chicago isn’t really applicable to the next few quarters. But over the long haul, if that scenario is “stretched out over many years,” then low rates may really damage the economy, and especially those older bank savers just trying to get by.