Low interest rate policy (policy of low interest rates, easy money policy)

Measures taken by the central bank with the aim of keeping interest rates artificially low. The intention is to stimulate investment. However, these are primarily determined by profit expectations. In the absence of such expectations, even a zero interest rate does not generally attract new investments. Sometimes it seems that this undeniable fact is forgotten by central bankers. Also, a further interest rate cut by the central bank is unlikely to have much effect if the interest rate level is already low; in other words, the central bank’s interest rate policy is constrained. — Arguably, however, the low interest rate will increase the unemployment rate. For if real wages do not fall to the same extent as the cost of capital – and this is the rule given the rigid conditions on the labor market – many companies will replace labor with the now cheaper capital. First and foremost, jobs in the low-wage sector will be lost. – Then the “cheap money” is channeled into uses that generate a comparatively low return (real estate, “cement gold”) instead of into long-term (noncurrent) growth-promoting investments for the purpose of innovations in manufacturing and the product; the scarce factors thus no longer reach the best host (to the most favorable allocation of resources) via the interest-allocation function. When, in the course of the financial crisis following the subprime crisis, the ECB kept the interest rate very low, many private households in Germany went into debt and invested the money speculatively in real estate even in foreign countries that had been cheaper until then – for example, in Ireland and Lithuania – which caused real estate prices to skyrocket there. Capital is thus flowing into less productive and/or risky uses. – Furthermore, low interest rates stimulate luxury consumption. Private households are borrowing cheaply, for example to take a round-the-world trip. And because saving is often not worthwhile at all – the inflation rate is higher than the interest on savings deposits – private households will consume more anyway; and this happens with far-reaching consequences at the expense of provisions for illness and old age. – With free movement of capital, carry trades will keep the cheap money in the domestic market – e.g.: Japan around 2000, Western Europe around 2009 – and invest it abroad at higher interest rates (higher interest bearing) – at the time: primarily in government bonds in the USA. In addition, internationally active companies will also channel the funds raised at low interest rates to affiliated companies abroad. Thus – the exchange rate of the country sinks with the low-interest policy; the imports – in Japan around 2000: Crude oil, food – become more expensive, and thus also the cost of living rises, This however hits above all the recipients [CH: Bezüger] of lower incomes: it comes to a redistribution of income. – The history of finance can convincingly prove that low interest rates encourage governments to incur additional debt and to distribute the borrowed money to the electorate, especially in the case of upcoming elections. Such election gifts rarely contribute to an increase in economic productivity. – In times of low interest rates, stock corporations regularly took out cheap loans in order to buy back their own shares with the money; in this way, share prices are artificially driven up. – In addition, interest rates kept low by monetary policy also mean losses on households’ bank deposits. The latter now receive only a very low interest rate for their deposits. According to precise calculations, Germany’s citizens lost roughly EUR 58 billion a year as a result of the low interest rates on bank deposits in the wake of the central bank’s low interest rate policy in dealing with the financial crisis triggered by the subprime crisis. Thus, the group of savers and those paying for their old-age pensions had to bear the brunt of the financial crisis, which is often not mentioned at all. – Also to be thought of are charitable associations and foundations, whose capital now yields less return. They now have to reduce their services, such as the awarding of scholarships, to the detriment of society as a whole. – But insurance companies, especially life insurance companies, are also easily thrown into difficulties as a result of the low interest rate policy. This is because insurance companies traditionally give their customers a lifetime interest rate guarantee in their policies. Now, however, the insurance companies can only invest the incoming current premiums at an interest rate that is far below the guaranteed interest rate. In view of this, the Federal Financial Supervisory Authority (BaFin) requires German insurance companies to hold special reserves in order to be able to meet the benefits guaranteed to their customers; under current law, it is virtually impossible for insurance companies to reduce guaranteed interest rate commitments. This puts German insurers at a competitive disadvantage in the highly competitive international market for insurance services. – Finally, the low interest rate policy is driving up commodity prices. This is because insurance companies and pension funds, in their desperate search for returns, invest part of their assets in commodity futures markets. – Low interest rate policy is therefore economically inconsequential, and it can have a devastating effect on social policy. Moreover, its long-term effects are hardly foreseeable. If interest rates are deprived of their function as a price for capital, this will lead to disorientation (general confusion about financial decisions and generally how to act economically) in the financial market, and it is very likely that this will cause major distortions in the economy as a whole. – See presumption, central banking, buyouts, central banking, distribution freeze, impact study on long-term guarantees, building society contract, oversaved, bubble, speculative, bubble-formers, carry trades, cash flow effect, diet yield, expropriation, cold, financialization, financial investment, fragmentation, money, cheap, money oversupply, real estate bubble, crisis, central bank-induced, liquidity trap, lie-and-deceive thesis, negative interest rate, zero interest rate, Phillips theorem, quantitative easing, yield chasing, repression, financial, debt drug, subprime crisis, stealth policy, vault boom, redistribution, central bank-induced, constitutional article one, debt incentive, path inflation, interest rate differential, interest rate, natural, interest rate, kept low, interest rate allocation function, interest rate incentive, interest rate cut policy, interest rate reserve, zombie bank. – Cf. Financial Stability Report 2010, pp. 102 ff. (effects of a low interest rate policy on the risk-bearing capacity of life insurers), Financial Stability Report 2012, pp. 42 ff. (low interest rate policy encourages higher risk-taking; insurance companies are particularly affected by low interest rate policy), ECB Monthly Bulletin of August 2013, pp. 50 ff. (Stock market development under the low interest rate policy; many overviews), Financial Stability Report 2013, p. 54 (Problems of building and loan associations in view of low interest rates), p. 118 ff. (Problems of insurance companies), BaFin Annual Report 2013, p. 133 (Five-year forecast calculation in the context of preventive supervision of insurance companies and pension funds in view of the low interest rate environment).

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University Professor Dr. Gerhard Merk, Dipl.rer.pol., Dipl.rer.oec.
Professor Dr. Eckehard Krah, Dipl.rer.pol.
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