Rates boost capital purchases

Ralph Nader, the scion of fuming consumer advocacy, recently penned an open letter to Janet Yellen, chair of the Federal Reserve. In it, Nader suggested that Yellen should “sit down” with her economist husband for some advice.

Knowing how well that note would’ve been received at the Hicks household, it is hard to imagine what outcome he expected. It seems, though, he wants her to increase interest rates to help household savers. Still, other than assessing Nader’s perennially poor analytical skills, there are three good economics lessons embedded in this exchange.

First, Nader is rightfully concerned that savers have suffered from a lengthy period of low interest rates on bank deposits. What he seems not to grasp is that nearly all of us are both borrowers and savers. So, low deposit interest rates will be, for most families, offset by lower rates on mortgage interest, credit card and other consumer debt rates. There is no clear class of people exclusively damaged by low interest rates.

Second, interest rates are the price of capital investments. They reflect the value borrowers place upon the items they purchase, most particularly productive capital and equipment. They are not the whimsical beast of a government-sanctioned financial system but are determined primarily by market forces.

Since the early days of the Great Recession, all interest rates have been low. This reflects the low rate of return borrowers expect from new capital and equipment, which results in less borrowing.

Nader might not be familiar with the technical name economists have given this phenomenon. We call it a recession.

Finally, the immediate goal of the monetary policy in a recession is to reduce non-market interest rates in order to encourage an increase in borrowing. To do so, the Fed reduces the rate it charges banks to borrow funds, which in turn will reduce the market interest rates they charge their customers. Quite simply, the extra supply of dollars are intended reduce the market interest rate for borrowed funds.

The larger goal attached to the Fed’s effort to lower interest rates is to move the economy from recession to recovery. The lower interest rates boost purchases of productive capital such as new machinery, along with consumer goods such as automobiles.

The fancy economic name for this increased borrowing at lower interest rates is the law of demand.

There is reasonable disagreement over the timing, magnitude and impact of the Fed’s monetary policies. There are also reasonable questions about the role monetary policy may have played in fostering bubbles in the dot-com period of the ’90s, housing in the ’00s and today’s stock market.

What is not at issue is the intent and expressed goals of those policies to improve economic performance for savers and borrowers alike; they are more often than not the same person. This last point is the substance of Janet Yellen’s reply.

The only question this leaves me with is why Nader, with his apparently facile grasp of economic policy coupled with his ineffectual communication style, is not again a candidate for president?

Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to dr-editorial@greenfieldreporter.com.