Thursday, 21 April 2016 00:00

The Futility Of Low Interest Rates

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The chart below gives the consumer credit growth from 2003 to 2015 that has been compared with the fed fund rates during this period. This chart serves as a good example to prove that artificially low interest rates do little to spur consumer spending and growth in real economic activity.

 

Fed Fund Rates And Consumer Credit Growth

 

When policymakers started increasing interest rates in 2004, the objective was to tighten monetary policy. However, as the chart shows, consumer credit growth remained robust on the back of slack lending standards.

In other words, the central bank wanted to tighten monetary policy, but the increase in fed fund rates was a blunt tool as the banking industry eased lending standards.

After the financial crisis of 2008-09, interest rates were cut back to near-zero levels with the intention of boosting credit growth and consumer spending. However, two factors ensured that credit growth remained sluggish and still remains sluggish –

First, while the central bank wanted easy money to flow into the economy, the banking system became conservative and tightened lending standards resulting in weak credit growth.

Second, overleveraged consumers went cautious and remain cautious with economic uncertainty still prevailing in the US and the global economy.

The point that I wanted to make with this example is that policy rates are a blunt tool to spur credit growth and a lot depends on the banking sector.

While the positives of low interest rates are limited, it does encourage speculation across asset classes and volatility in asset markets. As The Telegraph reports, IMF recently warned that negative interest rates could fuel another dangerous “boom and bust” cycle if policymakers start to rely on them to boost growth. With $15 trillion on government bonds trading at negative yields, there are reasons to be concerned. Of course, the biggest bubble is building in the government bond market.

From an investment perspective, exposure to physical gold is a good investment option in a scenario where the world is moving towards negative interest rates. Further, equities are likely to do well as speculative investments increase. However, money is likely to move swiftly from one asset class to another and that will create more volatility in the coming years.

 

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