Hidden Cost of Low Interest Rates

As my Economics 411 class discussed this afternoon, typically short-run monetary policies reverse and the more "medium" and "long-run" environments take over economic behavior. It occurred to me, as I looked around the room at the other 18-22 year old students in this room, that most of my colleagues have never experienced anything outside of essentially zero nominal short-term rates during their economic lifetime (that is to say, when they first became aware of economic applications and had an understanding of interest rates). It occurred to me that there could be a hidden "bubble" that is not considered in the normal discourse of low interest rate environments: an unpreparedness of young economists for "normal" interest rate environments.

Part of this unpreparedness can be found by thinking of optimal savings decisions. For much of my life and the lives of my generation, there have been paltry returns on short term, safe savings. In fact, as shown in the graph above, certificate of deposit rates have nationally been below 1% (3-months) since March 2009, almost six years. The idea is further highlighted in the US News & World Report article titled 10 CDs with High Interest Rates:

To most, the certificate of deposit is a typical bank account: safe, reliable and far from sexy. But that wasn't always the case. It's hard to believe CDs returned double digits not too long ago, especially since they will probably never reach those rates again.

While the economic scholars that are in my Econ 411 class will be aware of the higher interest rate environments of the late 70s and early 80s, the environment that most Americans of my generation have grown up in have seen meager returns on savings accounts, checking accounts, and almost every other interest bearing asset. It is not difficult to believe that Americans as a whole, and especially my generation, have adjusted their investment psyches to only expect these low returns. They have come to accept that interest bearing assets do not provide adequate returns and seek other assets (stocks in particular) in search of these returns. I do not believe that my generation will be able to over come this negative stigma of CDs/savings accounts when making their investment decisions in the future, potentially making sub-optimal investment decisions.

Another part of a potential "bubble" within young economists is a lack of preparedness within "normal" interest rates environments. For most of my generation's economic education process, there has been a substantial focus on keeping the foot on the gas, which is to say keeping interest rates accommodating for economic expansion. While I can talk your ear off about the pros and cons of Quantitative Easing programs or the mechanics behind breaking through the zero lower bound, I am surprisingly unprepared for what to do in the good times. While my generation's economists do know the mechanics of raising interest rates, it seems as this seemingly simple policy might not be as straightforward as it once was. The Federal Reserve noted this exact problem in their press release Policy Normalization Principles and Plans:

However, in light of the changes in the System Open Market Account (SOMA) portfolio since 2011 and enhancements in the tools the Committee will have available to implement policy during normalization, the Committee has concluded that some aspects of the eventual normalization process will likely differ from those specified earlier.

Our generation, who has known nearly exclusively the process of monetary expansion, will now have to begin dealing with the unwinding of the massive quantitative easing programs, using a rule book that may becoming ever outdated. It may look counter-intuitive, but young economists could be rooting for another recession, so at least they will know what the heck they should do in response.