Bank Interest Rates and Inflation
Colorado Springs, CO
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Okay, I'm not an economist and when I get into this discussion, I will happily acknowledge that there are a lot of people much smarter on the topic than me. However, when I do a Google search looking for "experts" I don't find agreement there either. So I'll share my amateur views and provide some links.
First, in NORMAL times with GLOBAL economic stability, the Fed's ideal interest rate is targeted at around 2-3 percent, with the actual rate determined more by the demand for US treasury bonds. However, despite the economic improvement in the last 23 months, these are still not normal times as we will be digging ourselves out of the Great Recession for a couple more years yet with low interest rates in the forecast to 2014. In particular in parts of Europe (i.e. Spain, Greece, Italy) the economic uncertainty has led to a "flight to the safety of dollars." That means that with high demand, the Fed can comfortably set interest rates extremely low, and there will still be a demand to buy our treasury bonds. Another way of putting it is that our borrowing costs to support our debt are much lower.
One positive of that outcome is in the interest we pay on our national debt. While many of the Tea Party Republicans have been screaming bloody murder about our rising debt and raising the debt ceiling, the actual interest that we taxpayers pay on that debt has remained fairly flat in the last three years. In fiscal year 2008 (Oct 2007-Sep 2008), we paid $451 billion in interest on our gross debt of $10.0 trillion. For fiscal year 2011, our debt had increased to $14.8 trillion but the interest we paid on that debt was only slightly more at $454 trillion. In effect while our debt has increased by $4.8 trillion in three years, the borrowing cost of that total debt has increased only $3 billion as old higher yielding bonds are exchanged for lower yielding bonds.
On the other hand, while some economists would say that low interest rates will stimulate the economy because people will by nature choose to spend their money on new cars and such rather than leave their money in low yielding CDs, if, as you pointed out, the CDs are not yielding much interest, then people don't have much to spend anyway. I suppose that's one reason why the economic recovery is taking so long.
Regarding inflation, the Bureau of Labor Statistics monitors a basket of consumer goods to determine the change in the Consumer Price Index (CPI) from year to year. I won't go into the details as that is a sore point as well with many consumers. But the change in the CPI from year to year is a measure of that year's inflation rate, and is also used to set inflationary increases to Social Security benefits and Medicare insurance premiums. After two years of zero increases in Social Security benefits, starting January 1, 2012 retired seniors finally got a 3.6 percent increase. That increase will likely be eaten up by increased Medicare insurance payments next year, as well as the inflation on the consumer products that seniors buy.
A couple of more points, interest rates and inflation rates do not necessarily track each other closely...one lags the other. Furthermore, while inflation is supposedly controlled by the amount of money that the Fed injects into the economy, other factors like high energy prices can also have an inflationary effect as higher energy costs are passed along up the chain to the consumer. That's what largely caused the double digit inflation of the 1970s and early 1980s when oil prices quadrupled. Some economists would say also that the Fed policies in response to the inflationary effects of higher gasoline prices at that time were wrong, but I'll leave that for economists to argue.
The bottom line though is that people are feeling the effects of inflation, partly driven by higher energy prices, but at the same time the income that they would receive from interest on CDs or bonds has been going down because of the Feds actions on interest rates. This especially hurts income as higher yielding CDs and bonds mature and are renewed at the much lower interest rates of today.
What we really need is a big stimulative effect of spending by government on infrastructure, education, and other activities that can accelerate our slow climb out of the recession. But that's not going to happen in a big way until we get past the November election, and maybe not then if the Republicans win and implement an austerity spending program.
Okay maybe CBB can share his MMT perspective...