the generational impact of low interest rates

recession SOP = negative real interest rates

Standard procedure for central banks during times of economic weakness is to lower the short-term interest rate to the point where it’s negative in real terms–meaning the nominal rate is less than inflation.  By thereby making loans in effect free, the idea is that corporations will use this gift to boost capital investment, hire new staff and, by doing so, get the economy back on a positive footing again.  In the US (but not elsewhere), such a decline in rates has also almost (until now) always been a signal for consumers to head back to the malls.  And, of course, lower borrowing rates may also give a jump start to housing.

Where does this economic windfall to borrowers come from?

…from savers.

The idea is to shift purchasing power from people who are less likely to consume to those who are more likely to spend–and to borrow money to do so.  The shift is from holders of fixed income instruments to borrowers–from old to young, from wealthy to less affluent.

In a world where the holders of fixed income were by and large the very wealthy, where older citizens had defined benefit pensions and where the period of negative real interest rates was relatively brief, this idea works fine.

not so good for today

In today’s world, however, Baby Boom retirees have only 401ks and IRAs and there’s no end in sight to the time of zero interest rates (the Fed has just said it will continue for at least the next two years).  As a result, “orthodox” money policy has two unintended consequences.  Both relate to older Americans.

a simple example

Suppose you’re on the verge of retirement, have a $50,000 salary and think you will adjust to a $40,000 a year lifestyle after you stop working.  Let’s say you expect to collect Social Security benefits of $15,000 a year and will rely on Medicare for medical benefits.

That leaves $25,000 a year to come from your savings.  At today’s money market rates of, say, .1%, how much do you need to have to avoid dipping into principal if all your savings are in vehicles like this?   Answer:  $25 million.

Suppose you have a blend of half cash and half 10-year Treasuries.  How much do you need then?  Answer:  $1.9 million.

If your retirement savings are $250,000, you’re going to run out of money in a little more than ten years after you stop working!

(Yes, I know that my numbers overstate the problem.  But not by that much.  Also, think about it–picking a (literal) “drop dead” date when your money runs out is a harder topic to raise than you might imagine.)

two conclusions

1.  In all likelihood, if you’re a Baby Boomer in this situation, although you’d probably like to retire, you can’t afford to.  You’ve got to hang on to your job for as long as possible.  This ends up making it impossible for a new entrant into the workforce to occupy the position that you normally would have vacated.

2.  You’re going to be very strongly opposed to changes in government entitlement plans, no matter what the arguments in favor are.  You don’t see you have any other choice.

Is there a solution to this unacknowledged problem?  Yes, an obvious one.  Use fiscal policy rather than money policy to stimulate the economy.  Unfortunately, this is unlikely to happen, in my opinion.  As a result, the plight of many Baby Boomers caused by the direction of money policy will act as a counterweight to its effectiveness.

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