• Robert Fry

Why Does The Fed Hate People Like My Parents?

My late parents, a dairy farmer and a high-school librarian, were children of the Great Depression, born in 1932 and 1934. They were relatively risk-averse and not well acquainted with the stock market. Aside from 10 shares of AT&T and the shares in the Baby Bells they got when AT&T was split up, they didn't own stock. They put their money in the bank, in savings accounts and certificates of deposit. They expected to fund their retirement with the three-legged stool of Social Security, my mom’s pension, and the interest from their savings.

When my mom died in 2007, the monthly pension and Social Security checks were reduced, but my dad, who turned 75 that year, still had plenty of money in the bank. The interest plus a gradual drawdown of the principal should have been enough to augment his Social Security and survivor's pension and allow him to live out his remaining years in comfort. The Federal Reserve had other ideas. In response to the Great Recession, they cut interest rates to zero, THEN LEFT THEM THERE UNTIL DECEMBER, 2015. My dad's interest income dried up, and he had to withdraw his savings from the bank much more rapidly than he had planned. When worsening dementia forced him into an assisted-living facility in 2015, we sold the family farm to ensure that there would be enough money to pay for his care. He died in 2017, so he never ran out of money, but if he had lived to 94, as his father did, he might have.

My dad is gone, but Zero Interest Rate Policy is back, and people like my parents are suffering again. Historically, the real after-tax return on savings accounts has been negative, in part because the IRS taxes nominal interest income rather than real (inflation-adjusted) interest income. It got even more negative when interest rates were driven down to zero during the Great Recession. Now, with zero interest rates AND high inflation, it is extraordinarily negative. Risk-averse people with money in the bank, many of them elderly, are having their savings expropriated by the combination of high inflation and low interest rates.

As a macroeconomist, I recognize there are times when low interest rates are needed to stimulate growth, and that old folks with money in the bank sometimes need to take one for the team. But the Fed seems to fall for the fallacy that low interest rates are inherently a good thing and are always good for economic growth. They are wrong on both counts. Those who believe low interest rates are a good thing are making the implicit value judgment that people who save and who put their savings in the bank are somehow less deserving than people who borrow or who put their savings into stocks. I would take issue with that value judgment.

Those who believe that low interest rates are always good for economic growth need to read Markus Brunnermeier and Jann Koby’s paper, The Reversal Interest Rate, which shows that rate cuts can be contractionary once interest rates fall below a certain critical level. They derive this “reversal interest rate” from the impact of interest rates on bank profits and the incentive of banks to lend, but you can get the same result from a reduction in the interest income and consumer spending of elderly savers in an aging society. Interest rates were below the reversal rate for most of the 2009-2020 expansion, which helps explain why the expansion was so anemic. Strong growth and rapid inflation indicate that we’re not below the reversal rate now, but we could get there in the next year or two if the Fed waits too long to raise rates.

Despite my parents’ risk aversion and my agrarian anti-finance roots, I learned from my graduate school classmates and my colleagues at DuPont's pension fund that the best way to build wealth is by buying stocks, and I accumulated a respectable stock portfolio by dollar-cost averaging into index funds over my 30-year corporate career. The Fed's policies since 2008 – and especially over the last 17 months – have benefitted me immensely. But while the value of my portfolio has risen to new highs, people like my late parents are receiving little if any interest income and are seeing the real value of their savings eaten away by high inflation.

The Fed should serve all Americans, not just the financially astute (and relatively well-off) who own stocks. When they don’t, they skew the distribution of income and wealth, stoking populist political movements on both the left and the right. For the benefit of the U.S. economy and elderly people with money in the bank, the Fed needs to raise rates sooner and more rapidly than their forecasts suggest.

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