Chart of the Week
The Paradox of Thrift
by Michael Hayhoe
The Fed Is Bedeviled by Keynes's Paradox of Thrift (see graph), "The economist John Maynard Keynes warned that ultra-low interest rates would backfire on central banks seeking to spur borrowing and spending, yet they seemed surprised that the current recovery is the weakest in postwar history after cutting rates to near zero, or even below in some cases.
Keynes is credited with popularizing the “paradox of thrift,” which is the economic theory that posits people tend to save more during recessions as rates fall to offset the income their savings is not generating. Of course it is the case that when you save more, you spend less. Since the U.S. economy is fueled by consumption, it also stands to reason that growth suffers as a result.
It’s been two years since Swiss Re produced a report that calculated U.S. savers had foregone some $470 billion in interest income. The analysis was based on what rates would have been had the Federal Reserve followed the Taylor Rule, which would have put rates, then at zero, at 1.7 percent.
Even as the Fed has begun to raise rates, it is clear that hundreds of billions of dollars have been squirreled away as savers play defense to counteract the Fed’s ultraloose monetary policy. Some $11.7 trillion is sitting in bank deposits, up from $7.23 trillion at the start of 2009 shortly after the Fed cut rates to near zero, central bank data show."
This is from a great Danielle DiMartino Booth Bloomberg Article talking about the unintended consequences on ultralow interest rates. Very much worth the read. She closes with these great lines "As Keynes’s paradox dictates, retirees have nothing but impossible choices to make. Either they sleep with one eye open, hoping they don’t outlive their prudently stashed savings which are not keeping pace with the rising cost of living. Or they sleep with the other eye open, with their principal at risk, the price they pay for being exposed to risky securities whose returns do outpace inflation. Paradox indeed."
Mike Hayhoe is Branch Manager & Senior Investment Advisor at Independent Wealth Management Canaccord Genuity Wealth Management, Kitchener