Why be normal?
That’s a catchy phrase for a T-shirt. But for economic policy, normal is the best strategy.
Policymakers at the Federal Reserve need to normalize interest rates soon. The consequences of low bank interest rates are becoming more and more severe.
The policymakers see low interest rates as a way to spur business investment and consumer spending. The unseen consequences of this continuing low interest rate environment include lower income for retirees, less small business development and higher risks in public pensions.
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Households with a large portion of their wealth in savings accounts, particularly seniors, have made do with lower income for many years now. This lowers their discretionary spending and increases reliance on government-support programs. Higher rates will boost income for retirees and may increase consumption.
A low interest rate environment favors big companies and big banks. Consumers can more easily borrow for big-ticket purchases from large corporations, like cars and appliances. But spending on everyday items from small businesses, like clothing and restaurant meals, often declines.
Under current Fed policy, the spread between short-term and long-term interest rates is low, hurting community banks and credit unions. Banks make money by borrowing through short-term savings accounts and lending at higher rates for longer terms. When this interest margin is squeezed, large banks take business from their smaller competitors.
Furthermore, low interest rates are doing nothing to create more small business loans. According to the National Federation of Independent Businesses, 95 percent of small businesses have all the credit they need.
The Fed’s low interest rate policy also impairs the ability of pension, insurance and other savings plans to meet their obligations. State pension programs face the greatest difficulty if interest rates don’t rise soon. Large state and municipal pension programs attempt to overcome the low rates by moving money away from bonds to riskier investments.
The Public Employee Retirement System of Idaho is well funded, but this valuation depends on an investment return of 7.75 percent over the long run. With long-term bonds nowhere near this rate, PERSI has chosen to keep a significant portion of the fund in more risky investments. As of July 2015, PERSI has only 27 percent of the $15 billion fund allocated to bonds, compared to a stated benchmark allocation of 30 percent.
The Federal Open Market Committee meets again in September, and this summer some members of the committee indicated they will vote then to start raising interest rates. A commitment to do so will improve retiree incomes, level the playing field for small businesses and banks, and reduce the risk-taking in public pensions.
It’s a good time to be normal again.