Danielle DiMartino Booth: The Fed is bedeviled by Keynes' paradox

By Danielle DiMartino Booth
Bloomberg News
Thursday, March 30, 2017

The economist John Maynard Keynes warned that ultra-low interest rates would backfire on central banks seeking to spur borrowing and spending, yet they seemed surprised that the current recovery is the weakest in postwar history after cutting rates to near zero, or even below in some cases.

Keynes is credited with popularizing the "paradox of thrift," which is the economic theory that posits people tend to save more during recessions as rates fall to offset the income their savings is not generating. Of course it is the case that when you save more, you spend less. Since the U.S. economy is fueled by consumption, it also stands to reason that growth suffers as a result.

It's been two years since Swiss Re produced a report that calculated U.S. savers had foregone some $470 billion in interest income. The analysis was based on what rates would have been had the Federal Reserve followed the Taylor Rule, which would have put rates, then at zero, at 1.7 percent.

Even as the Fed has begun to raise rates, it is clear that hundreds of billions of dollars have been squirreled away as savers play defense to counteract the Fed's ultraloose monetary policy. Some $11.7 trillion is sitting in bank deposits, up from $7.23 trillion at the start of 2009 shortly after the Fed cut rates to near zero, central bank data show.

Although the Swiss Re report acknowledged that higher home prices and stock market values somewhat offset what households missed out on in earned in interest, the caveat was that the bulk of the wealth created via those two avenues flowed to the wealthiest. Two years on, the skew is, if anything, more acute. Even as the prices of stocks and luxury homes have scaled new heights, for the vast majority of Americans, so has the cost to buy or rent a home and that of healthcare. ...

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