Who doesn’t like low rates
Some facts of life seem like such riddles that even professionals can’t provide answers appropriate enough to satisfy the curiosity of common people. The Central Bank of Turkey recently slashed its overnight lending rate by 150 basis points to 10 percent. This expected decision, which aimed to give a push to already slowing growth, was welcomed by business leaders and politicians. However, a discussion has begun in some Western countries, where interest rates were also slashed in order to revive already-weak demand: Who doesn’t like low interest rates and why? Are low interest rates good for the economy on every occasion?
Answering the first question indirectly is very easy. Low interest rates are good for governments and businesses, but are not so good for common people who are trying to live off the already-limited savings in their bank accounts. Answering the second question is not so easy. Low rates might increase total demand but also force ordinary people to look for different investment alternatives besides keeping their savings in their bank accounts. As a result, the volume of bank deposits might begin to shrink, which means a probable decrease in lending even if the rates are lower.
Another riddle is the trade-off between spending and saving. Lower rates not only increase investments but also consumption expenditures. This is an expected result in some countries that are attempting to prevent a second wave of recession through loose monetary and fiscal policies. One of the most important tools of a loose monetary policy is a lower interest rate. Another important tool to offset the negative effect of lower interest rates on domestic savings is to also increase the volume of liquidity. There is always an inflation risk if these policies are exaggerated. However, it is almost impossible to estimate the limit of the implementation which must not be exceeded to avoid creating inflationary pressures.
Which interest rate increases demand while also avoiding decreasing domestic savings? During the golden days of economic planning and programming, a new concept was introduced into the literature of economics, “optimum savings ratio.” If econometric studies and research could estimate that ratio in a particular economy, then a second round of study would follow to estimate the exact interest rate to realize that. Unfortunately, even financial markets were not so dynamic and not globalized like today; it was understood in a short time that it was almost impossible to estimate rates, and even if they were estimated, it was also impossible to manipulate markets for those rates.
Another important question is thus this: Is it possible to hold interest rates imposed by central banks on the same level when markets try to dictate different levels? The worldwide examples show that even if there are no wild fluctuations in an economy, markets are always successful in dictating what they want or, more correctly, what they need. It means that central banks can hold interest rates on a fixed level only for a limited period of time. It is necessary to observe the markets first and then challenge what’s happening there.
One last note: Interest rates that are lower than inflation force ordinary people to subsidize governments without even knowing it. Economists call this “financial repression.” According to some historians, after World War II, that policy helped Western countries manage their accumulated public debts. However, as some major economies are now slowing down, it is difficult to estimate the impact of this policy on savings, spending, inflation and private borrowing – not only in Western countries, but also in Turkey.