Monetary Policy The Vicious Circle of Zero Interest

Germany's poorest and most indebted citizens are benefitting from the zero interest rate policy, but it is detrimental to the majority of the population.
Germans have reacted to low interest rates with increased spending while the level of savings has dropped.

The consequences of the extremely expansive monetary policy on society have been pondered for years. In the history of economics, there has never been such a long period of time where the prime rate remained at almost zero while lending rates were correspondingly very low and yields for reasonably secure investments at historic lows.

Joseph Stiglitz, the American economist and Nobel Laureate economist, warned three years ago the U.S. Federal Reserve’s monetary policy could continue to widen the societal gap in the U.S.

In Germany, on the other hand, public debate concentrated on the “expropriation” of savings account holders accompanying the low interest rate policy of the European Central Bank (ECB).

As is so often the case, the truth is more complicated. This is evident in a recent study by Judith Niehues and Markus Demary of the Cologne Institute for Economic Research. They examined the effects of the low interest rate policy on wealth distribution in Germany using data from a survey of more than 3,500 households.

The negative impact of lower earnings on interest outweighs the positive effects of cheaper debt service for all income levels.

The research found it’s the ten percent of the population at the bottom of the wealth and assets scales that benefits most from the low interest rate policy. This segment of the population is relatively deep in debt and, therefore, the benefits of lower interest rates on debt generally outweigh the disadvantages of lower interest earnings on savings. In contrast, the low interest rates are unfavorable, if not outright detrimental, to the other 90 percent of Germany’s population.

Another line separates households by age. Younger households often still have high mortgage debts, so the negative effect of low interest rates is balanced against lower debt service. Older households generally have paid off their homes, but now receive less interest on their retirement savings. This is where criticism of the “expropriation” of the saver is most applicable, even if the term is incorrect. After all, no one is entitled to a certain level of interest.

Researchers found another picture when examining the distributional consequences based on income groups. In this case, the negative impact of lower earnings on interest outweighs the positive effects of cheaper debt service for all income levels. This is due not only to the level of debt, but also to the saving behaviors of similar income classes.

In contrast to the U.S., for example, ownership of stocks plays only a minor role in the higher-level income classes in Germany while property ownership is distributed fairly evenly in the population. On the whole, therefore, it cannot be said the extremely low interest rates have increased the gap between the rich and the poor in Germany.

Yet that doesn’t mean low rates don’t cause economic and social problems. In fact, the low interest rate policy threatens to permanently establish a change in saving behavior. So far, Germans have reacted to low interest rates with increased spending while the level of savings has dropped by about 1.5 percentage points since the financial crisis in 2008 to 9.2 percent. The increased spending also is fed by fatalism. It isn’t worthwhile to save anymore, so why not treat yourself to some new furniture or a new car? Moreover, worries about loss of employment are decreasing, and with that, the importance of precautionary savings.

The longer the situation continues, however, the clearer it will become to middle-aged adults that they must greatly increase their retirement savings efforts if they want to maintain their living standards in old age. They must curb their spending. Meanwhile, retirees who have a significant portion of their retirement income in interest rate-sensitive capital income will be able to spend less because these earnings will be meager. This would weaken economic development, allowing the low interest rate phase to become a structural phenomenon. Then, the ECB’s monetary policy will have created a vicious circle.

Most of Europe’s governments would have no problem with that since they are in the same position as overly indebted households. Looking at the positive side, a long-term zero interest rate gives them more time for necessary structural reforms. Or, it can be seen much differently. They can delude themselves that the current economic and fiscal policy is sustainable for a few more years.


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