I am a strong proponent of making the Fed's current near 0 percent interest rate policy permanent. A low-rate policy encourages long-term investments for businesses to expand and become more efficient, and for households to invest in new homes, improvements and appliances that can also add to efficiency, all of which increases long-term productivity and our real wealth. Low rates also keep the cost of holding business inventory down, and lower interest costs mean businesses sell at lower prices and also keep the shelves stocked, helping to prevent sudden shortages from disrupting output and employment.
However, savers are on the other side of low interest rates, and the private sector overall, including households, is a net saver. And lower interest rates mean less income to savers, which hurts the economy. But there are more dollars saved in the economy than borrowed. But how can that be? Well, for every dollar borrowed from the banks, there's only a dollar saved. Both sides are equal. So you would think a cut in interest rates would only shift dollars away from savers to borrowers. But don't forget the government is a large payer of interest to the economy which holds trillions of dollars of government debt. And how does that happen?
The "federal deficit" is when the government spends more than it taxes. And when government spends a dollar, there are only two possibilities. Either that dollar is used to pay taxes and is lost to the economy, or it remains in the economy as what we call "monetary savings." And so the government deficit - dollars spent by the government and not yet used to pay taxes - is in fact our monetary savings. And so this explains why the businesses and households in the economy are able to save so much. In fact, government deficit spending adds exactly that much to our savings, to the penny, as any government accountant will confirm!
So this means that when the Fed lower rates, the Treasury pays less interest to the economy on its debt, and that means less income for the economy. In other words, with the economy on balance a big saver, lowering rates removes interest income and therefore acts much like a tax increase, and this hurts the economy.
Fortunately, there are very "user friendly" ways to offset this interest income lost to the economy. These include tax cuts or public spending increases. The choice is political, as either alone or in combination can easily be sized to make sure the economy has enough income to sustain high levels of output and full employment. In fact, the problem today is that, for the size government we have, along with the low interest rate policy, the economy is grossly overtaxed and starved for income.
The remedy is quite simple. We can, again, either cut taxes (I've proposed a full payroll tax holiday, which would increase the average working family's take home pay by over $600 per month) and/or increase public spending (I've proposed establishing a minimum social security payment of $2,000 per month). Others options for increasing public spending might include restoring our public infrastructure for the likes of transportation, public safety, healthcare or education. Based on today's weak economy, I calculate the needed adjustments to be about $1 trillion per year.
Additionally, during an expansion, the private sector prefers to hire people already working and not those unemployed, so I've also proposed a federally funded "transition job" that pays $10 per hour to anyone willing and able to work. This facilitates that critical transition from unemployment to private sector employment, as it's well established that business far prefers to hire people already working.
So yes, lower rates hurt savers, which weakens the economy. And therefore you would be right to think that Fed rate hikes would help the economy. But why not instead make the low rates permanent and eliminate payroll taxes and increase Social Security payments to make up for the lost interest income, while keeping rates low for investment, home mortgages, car loans and lower costs for businesses to keep prices down.
And what about the budget deficit? Well, with a permanent 0 percent rate policy, there is no interest to speak of being paid, so you can forget about all those issues. And so the trick is to cut taxes or increase spending just enough to keep the economy humming along at full employment, which is what the real goal is.
About Warren Mosler Co-Founder of the Center for Full Employment And Price Stability
Mark Weisbrot Co-Director of the Center for Economic and Policy Research,
Mark Calabria Director of Financial Regulation Studies at the Cato Institute
Jeffrey Madrick Senior Fellow at the Roosevelt Institute