No matter where interest rates stand, there are always winners and losers.
I remember when choosing a bank was based on whether they offered an iron, toaster, or electric blanket as a bonus. Back then, a 7-year CD had a 7.75% interest rate (8.17% APY). A retiree could deposit $100,000 and earn $8,000 a year in interest!
At the same time, for homeowners and new businesses, borrowing costs were high. When we bought our first home in 1976, our mortgage rate was 8.75% for 20 a year mortgage. Two years later, when we considered refinancing to build a barn, the rate had climbed to 9.25%. My wife said, “Maybe we should stay put; we may never see 8.75% again!” I replied, “Maybe in the future, 9.25% will seem low.”
For the first 10 years, we were both right. Over the next 40 years—wow, were we wrong!
Fast forward to 2021, and mortgage rates were around 3–4% on a 30-year mortgage. That was a fantastic deal for borrowers. But for retirees, the story wasn’t so good. To earn the same $8,000 in interest, a retiree would need to deposit around $1 million. And that doesn’t even factor in inflation for how much $8,000 can buy today!
So, here's the Good, the Bad, and the Ugly of low interest rates:
The Good:
- Cheaper Borrowing: Lower interest rates make it cheaper to borrow money, helping people buy homes, cars, and pay for education. Businesses can borrow more easily to invest and grow.
- Economic Growth: When borrowing is cheaper, people spend more, and businesses invest more. This stimulates the economy.
- Government Borrowing: Lower rates make it cheaper for governments to borrow money, helping to fund programs, especially during tough times. But this can also be a problem, as we’ll see with the "Bad”.
The Bad:
- Hurts Savers: Low interest rates hurt people, especially retirees, who rely on interest from savings accounts or bonds.
- Risky Investments: Low rates may push people to seek riskier investments in search of better returns.
- More Debt: People and businesses might borrow too much, leading to financial trouble if they can’t pay it back.
- Government Debt: While government debt has increased massively, the payments toward that debt haven't changed much, thanks to low rates. But what happens when these low-interest Treasuries need to be refinanced at higher rates? Where is the money to pay the higher interest costs going to come from?
The Ugly:
- Asset Bubbles: When borrowing is too cheap for too long, prices in areas like housing or stocks can skyrocket, leading to crashes.
- Inflation: Keeping rates low for too long can cause prices to rise too fast, reducing the value of money.
Low interest rates can help the economy by making it easier to borrow and spend, but they also cause problems for savers, encourage too much debt, and fuel price increases.
Policymakers try to manage interest rates carefully, but is achieving the right balance really possible? Probably not. Economic decisions are complex, and their effects don’t always match expectations in terms of timing or impact. Getting that balance is as much an art as it is a science. And all this assumes decision-makers don’t have the personal, political, or behavioral objectives the rest of us have!