Podcast: Macro Waves
Negative interest rates, a blessing for shoppers, a headache for savers 10/28/2019

How negative rates can impact households and their savings? In this second part, we will see with William De Vijlder that there is no easy answer to this question given the heterogeneity of households and assets.

TRANSCRIPT // Negative interest rates, a blessing for shoppers, a headache for savers : October 2019

Part 2 - Negative interest rates, a blessing for shoppers, a headache for savers

When interest rates are very low to negative, is it good or bad news for households?

The textbook answer is that it’s good news because low rates boost GDP growth and hence household income growth. Behind this simple answer, there is a world of complexity though questions like:

1. Do we look at assets, at liabilities or at both, i.e. assets minus liabilities?

2. Do we look at the household sector in the aggregate or at specific types of households?

Let’s start with the liability side. First of all, what do you mean by it?

By liabilities, I mean three different things:

1. The value of existing credits

When interest rates drop, often credits can be refinanced at a lower rate. Think of mortgages: this makes households better off.

 

2. The ease of access to new credits

Access becomes easier because the interest charge on the loan of a certain size declines. Banks may also ease their standards.

 

3. The present value of future commitments

This is a tricky one. Future commitments are expenditures you will have to make in the future, typically when you have retired. To assess what this represents today, they need to be discounted. The discount rate is the interest rate you get on your assets without taking any risk. And here’s the issue: when interest rates drop, the present value of future commitments increases significantly.

Let’s now turn to the assets side.

With assets I mean several things:

1. The value of existing assets

The price of an asset is the discounted value of future cash-flows. When interest rates decline, all else remaining the same, the asset price increases. Think of the reaction of equity, bond and property prices to a decline in the official interest rates.

 

2. The expected return on these assets

When the central bank cuts interest rates, bank deposit rates decline, so going forward, financial income will be lower. The same applies when investing in bonds. Today, many markets even have negative yields, even for long maturities.

However, most households can avoid being subject to negative interest rates by putting their savings in a bank deposit, which for legal and/or commercial reasons are offering a positive or at least non-negative rate of interest. There are exceptions though: private banking clients of certain banks in certain countries.

 

3. The capacity to let assets grow, that is to save

 

So the difference between assets and liabilities is then simply the net effect.

Indeed, but it’s very hard to determine because influences go in opposite directions. In the end, the key question when assessing the effectiveness of a very expansionary monetary policy is what happens to the savings rate.

Several channels can be distinguished?

1. Faster economic growth will lead to an increase in employment and hence household income. This should boost the volume of household savings.

2. Low rates reduce the opportunity cost of spending money today, rather than tomorrow. This is called the substitution effect. It reduces the savings rate.

3. The income effect has the opposite effect: a decline in interest rates implies lower financial income out of a given size of financial assets. As a consequence, households may decide to save more and spend less.

4. Households may also spend less, save more, take a mortgage to buy a house because rates are low. This implies a substitution between consumption and capital formation.

5. Finally, declining interest rates may boost property prices and equity markets. This can support consumer spending via a wealth effect, and hence weigh on the volume of savings.

Then there is the question of whether we look at the household sector in the aggregate or at specific types of households? Why is the difference important?

1. Households are very different, they’re very heterogeneous.

2. Some considerable debt and limited assets, so they gain from lower interest rates when they refinance a loan.

3. Others have equities and property. They gain as well.

4. Still others have bonds: they are faced with declining coupons. If coupons are halved, you need twice the assets to maintain the same standard of living if you expenditures are paid for by the coupons.

5. People may be unemployed and rate cuts may indirectly give them a new job.

So depending who you consider, the effects of low or even negative rates can be hugely positive (from unemployed to becoming employed) or very negative. Research by the ECB shows that the overall effect is positive.

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