A good question is asked by Alan Amdahl, an economics teacher of an Albany, Minnesota high school regarding the historic low interest rates of savings accounts across the country. The question he asks is:
'How can we teach students that they will be rewarded for saving given that returns on investments are currently so low?' The answer that is given by the former Federal Reserve Chairman, Ben Bernanke, is a little incomplete in my opinion. Mr. Bernanke attempts to make the point that interest rates have been low but '...they're low for a good reason... which is that our economy is still in a fragile recovery and low interest rates are intended to help the economy recover...' he goes on to say, '...ultimately, the best way to improve the returns attainable by savers was to do what the Fed actually did: keep rates low...'
So around the year 2008, the decision makers at the Fed decided to lower interest rates to near zero which indirectly meant lower savings rates for bank customers across the country. This was done for the purpose of... in Bernanke's own words '...so that the economy could recover and more quickly reach the point of producing healthier investment returns.'
The logic behind this course of action is to inspire economic activity in the form of borrowing loans for (1) business and (2) spending needs (1) Business -- With rates so low, it is easy for entrepreneurs and business owners to borrow money to start businesses and potentially create positive cashflow to expand businesses and create stable incomes for employees which can lead to higher consumer spending. (2) Spending Needs -- As was covered in my last blog, the mainstream financial media believes consumer spending is needed to nurture a strong economy. By people taking out loans to purchase homes, cars etc. it is expected that this spent money will get mixed into economy and hopefully spur growth. Has the economy recovered to the point where people can expect higher interest rates on their savings and investment accounts?
Depends on who you ask?
Bloomberg host, Tom Keene, asks how has 'interest rate illusion' determined business investments, sales and profits?
This video covers how the Federal Reserve may have to consider something else other than low interest rates to spur the economy. They bring up the suggestion of negative interest rates which basically means that instead of people earning interest a bank would begin charging you for depositing your money with them.
Even though negative rates is in the very early discussion stage right now it should be obvious that had low interest rates did their expected job of growing the economy then negative interest rates wouldn't be thought of in the first place. (A future blog will go into why negative interest rates are being considered at all.) Why Can't Individual Banks Offer Higher Interest Rates on Their Own?
Technically they can however this would be going against the grain of the very system that a bank is supported by. Thanks to fractional reserve lending banks aren't really in a position to offer higher interest rates to their depositors. They would first have to keep more cash in their reserves to comfortably satisfy higher rated accounts. Otherwise they would need access to the Federal Reserve's cash to meet the contracted demands of savers.
Since it is a typical practice of our central bank to purchase bonds (debt instruments) to create the cash available for banks to provide to their customers, the rates have to be manageable (lower) than a stronger healthier economy would be able to handle, in my view.
It may just be the first step to responsible banking if banks managed their lending and savings rates based on their ability to effectively attract money through discernment and stable investment choices as opposed to low cash reserve requirements and having the Federal Reserve available to bail them out with extra cash.
Considering the track record of the last 8 years, higher savings rates worth mentioning seem to be a long ways away. To answer Alan Amdahl's question posted at the start of this article:
'How can we teach students that they will be rewarded for saving given that returns on investments are currently so low?'
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