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Are Low Interest Rates Good?

The cost of borrowing money is at a record low. Low interest rates and cheap credit encourage people to spend more, and to save less. Is this good or bad?

Many argue that we need low interest rates to encourage spending. But low interest rates don’t actually encourage people to spend more money. Low interest rates simply encourage people to spend more money now, and less in the future. The opposite is true for high interest rates.

So what interest rate is best overall? Professor Davies says the best interest rate is the one that comes about naturally, without government intervention. Individuals know better than the Federal Reserve how and when to spend their money. Decisions on whether to consume more or save more is best left to individuals, not government officials.

Are Low Interest Rates Good?

Mortgage interest rates are at historically low levels and have been for a long time. Low interest rates are good for borrowers because it means that it costs less for them to borrow. But low interest rates are bad for savers because it means that they earn a lower return on their savings. Similarly, high interest rates are bad for borrowers because it means that they must pay more to borrow money. But, high interest rates are good for savers because it means that they earn more interest on their savings. In 1972, mortgage rates were 7 percent and the average American household’s debt was 76 percent of its income. Mortgage interest rates rose until 1981 and then fell. 

As mortgage rates rose, people borrowed less. And as mortgage rates fell, people borrowed more. Today, mortgage interest rates are almost half of what they were in the 1970s, allowing households to borrow about twice what they could afford then. Some argue that we need interest rates to be low so as to encourage spending. But, low interest rates don’t simply encourage people to spend more. They encourage people to spend more now in exchange for spending less in the future. Since borrowed money must be paid back, the additional spending that goes on today will be offset by lesser spending in the future when people pay back their loans. Similarly, high interest rates don’t simply encourage people to spend less. They encourage people to spend less now in exchange for spending more in the future. So what is the right interest rate?
The answer is the free market interest rate. The free market interest rate is the rate we get when the Federal Reserve does not interfere in financial markets. Individual borrowers and savers know better than the Federal Reserve whether they should give up spending tomorrow in exchange for more spending today or whether they should give up spending today in exchange for more spending tomorrow. When the Federal Reserve actively manages interest rates it replaces these people’s judgments about what’s best for them with the Federal Reserve’s judgment as to what’s best for them. The lesson is that borrowing and saving are really about deciding whether to consume more now and less later or more later and less now. And these decisions are best left to individuals.

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8 Comments

  1. Jonathan Taylor

    Depends on whether Americans choose to take an active role in their government. I think a lot of things we don’t suppose will happen today will be taken for granted at some point in the future, just as people 300 years ago couldn’t have imagined that we’d be living the way we are today.

    We just have to  keep working toward positive progress.

  2. Keith Knight

    Every economic downturn before the Fed’s creation in 1913 is refereed to as a ‘Panic’ (1789, 1819, 1837, 1873, 1893, 1907) because after people panicked the market adjusted.  It wasn’t until  1920 under Warren Harding was there a “Recession” that he refused to intervene in, thus it’s end in 1921.

  3. asexymind

    And, low interest rate now means, not only more spending now, but more spending on less profitable things. When interest rates are high, people are more hesitant to borrow unless it is truly valuable – leads to greater profit. Higher quality experiences, and higher profit business opportunities. If we want, not only more money available in the future, but better/more goods and services, we want the optimal mix – which is the market.

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