Unintended Consequences of QE & ZIRP (Philip Pilkington and Naked Capitalism)

THURSDAY, JANUARY 26, 2012

Philip Pilkington: Is QE/ZIRP Killing Demand?

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

Warren Mosler recently ran a very succinct account of why the Fed/Bank of England’s easy monetary policies – that is, the combination of Quantitative Easing and their Zero Interest Rate Programs – might actually be killing demand in the economy.

Mosler’s argument runs something like this: when interest rates hit the floor they suck interest income payments that might flow to rentiers and savers. And no, we’re not just talking about Johnny Moneybags refusing to buy his daughter a new Prada handbag (which, say what you will, creates job opportunities). We’re also talking about regular savers and, as the Fed recently noted, pension funds seeing their income fall – not to mention certain industries, like insurance, finding their profits lowered (and hence their premiums raised?).

Mosler sums it up well:

Lowering rates in general in the first instance merely shifts interest income from ‘savers’ to borrowers. And with the federal government a net payer of interest to the economy, lowering rates reduces interest income for the economy.

He then goes on to make the point that we’d have to see borrowers spending more than savers to see any real stimulative effect on the real economy. But alas, such is probably not the case.

The only way a rate cut could add to aggregate demand would be if, in aggregate, the propensities to consume of borrowers was higher than savers. But fed studies have shown the propensities are about the same, and, again, so does the actual empirical evidence of the last several years. And further detail on this interest income channel shows that while income for savers dropped by nearly the full amount of the rate cuts, costs for borrowers haven’t fallen that much, with the difference going to net interest margins of lenders. And with lenders having a near zero propensity to consume from interest income, versus savers who have a much higher propensity to consume, this particular aspect of the institutional structure has caused rate reductions to be a contractionary and deflationary bias.

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