Now that the Fed dropped interest rates, what happens to most American households? The Fed seems to think they’ll happily borrow more money at still lower rates, jump-start the economy, and live happily ever after. It hasn’t happened for ten years, but here’s to hoping. However, what’s far more likely is that the inequality divide dug by a decade of ultra-low interest rates will get still deeper and even darker – for all the Fed’s pantheon of theories both conventional and very much not, the simple math of what happens to a small savings account starkly shows why post-crisis monetary policy made U.S. inequality so much worse so much faster.
Assume I put $2,000 a year in a savings account paying a five percent compound rate of interest for twenty years; at the end of my twenty thrifty years, I have $69,438 to show for this in nominal terms. In real – i.e., inflation-adjusted dollars – I have $49,598 assuming two percent annual inflation. As a result, my $40,000 has earned me an additional inflation-protected $9,598 or 24 percent. Now take my same $2,000 for the same twenty years – i.e., $40,000 – and the same two percent inflation. Give me only the half of one percent interest rate paid at most on small funds since the financial crisis and, instead of $69,438, I have only $42,168 in nominal terms and only a real $30,120 – that is, I lost almost 25 percent of the funds I need to make ends meet by virtue of my thrift. Drop rates a bit, see inflation rise some more and it only gets worse.
Clearly, the Fed’s long-term, low rates have quashed the chances that an average household can save for a financial cushion against adversity, to fund a mortgage down payment, or to secure retirement. Although it took only three years for a young family to fund a mortgage down payment a generation ago, it now takes at least nineteen years even assuming higher rates than those that have prevailed since 2008.
This damaging result might be acceptable – might be – if lower rates spurred real growth that led to real wage increases. However, middle class wages now are still no higher than they were in 2001 when inflation is taken into account. Household income may be up in real terms, but that’s largely because many households are now subsisting on multiple wage earners and gig employment. As we noted in a recent Economic Equality blog post, fully one-third of Americans aren’t working as much as they want .
God knows how hard the other two-thirds is working to make ends meet, but we do know that most Americans have far more debt than durable assets. A little lower interest rate on all this debt might make it somewhat more manageable, but all this debt is still a system of deep economic malaise that slightly lower rates only makes worse.
The Fed’s post-crisis unconventional policy is founded on an extremely conventional hypothesis: if low rates spur growth, then ultra-low rates or even negative ones will make growth even faster and stronger. But, conventional theory was crafted in the years since the Second World War when the U.S. had a robust middle class with significant capacity to borrow when rates drop and to spend their debt on durable consumption with long-term equality advantages. With a hollowed-out middle class and significant changes in the structure of U.S. households, the Fed cannot make low rates stoke sustained, sound growth no matter how hard it tries. Indeed, GDP growth only began its halting recovery to levels at which prosperity might have been shared after rates started to rise in 2015.
The Fed believes it bought itself some “insurance” with the rate cut. Clearly, this is not insurance against political risk judging by President Trump’s tweets. It’s also not insurance against market volatility, which increased after the cut not just due to another Trump trade tweet, but also to growing doubts about Fed policy and higher bond-market risk. And, of course, Mr. Powell bought no insurance against worse inequality and thus greater macroeconomic, financial, and political risk. Instead, with the rate cut, the Fed has just gambled that it can somehow, sometime figure out how best either to normalize policy or come up with something better. Time is not on its side.