CBA vs RBA continued

A side-thought for retirees and savers: can lower interest rates actually hurt the economy?

A previous blog entry, CBA vs RBA, discussed how the Commonwealth Bank of Australia (CBA) chose not to pass on a full Reserve Bank of Australia (RBA) interest rate cut, lest it unduly hurt its depositors/ savers. Consequently, an interesting side-thought occurred to me (beyond the conspiracy theory that I entertained in the previous blog).

During economic slumps when the RBA tries to revive the economy by lowering interest rates, this is intended to encourage borrowing and investment, thus spurring the economy. It is unsurprising that lowering interest rates may hurt savers and self-funded retirees but (I’m assuming) it has been correspondingly assumed that this is only a small section of the economy, so lower interest rates will overall be stimulatory.

However, with the ageing population in many Western countries, isn’t it possible that as this section of society gets bigger, the stimulatory impact of lowering interest rates will progressively get more and more undone/ reversed by this growing contractionary impact, and may even get outweighed by it?

In Japan, for example, decades of low interest rates have failed to bring their economy out of its slump. Could one not argue that this is because Japan is a net-saver (like Germany and China), so low interest rates may actually hinder their recovery?

My temptation is to say ‘probably not’ – the stimulatory impacts will probably continue to outweigh the contractionary impacts. Even in net-saver countries, low domestic interest rates should encourage savers (banks, superannuation funds, even individuals, etc.) to search for higher interest rates internationally. And if they are successful in finding such investments, this should offset (even outweigh) any contractionary effects of low domestic interest rates. Even today, the globally low interest rate environment is not a result of a lack of productive investment opportunities, especially for a government that was committed enough to infrastructure and fiscal stimulus. And the sooner the government picks up this slack, the sooner the economy will recover and interest rates can be increased again.

Consequently, to the extent that low interest rates hurt savers and retirees, there should continue be an even larger stimulatory impact on borrowers and investors (including savers and retirees). Japan’s problems specifically, are more structural than a reflection of the management of their macroeconomic cycles (though there are arguments suggesting the latter could have been better over recent decades, but let's leave that discussion for another time).

However, it did give me an interesting thought. What if the government – in addition to providing proper fiscal stimulus through infrastructure investment – also had an automatic mechanism which compensated savers and self-funded retirees to the extent that the interest rate is lower than some pre-determined ‘natural’ rate? This would mean that not only will lower interest rates spur borrowing and investment, but these benefits won’t be (even partially) offset by savers and self-funded retirees being squeezed.

This would be a simple example of fiscal policy automatically supporting monetary policy, rather than monetary policy doing all the heavy lifting – especially when different groups in society are differently-impacted by interest rate decisions, and government can't be trusted to actively support monetary policy through deliberate investments.