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Low Interest Rates Subsidize Wealthy Households

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Tags Money and BanksMoney and Banking

10/21/2017

When the economy begins to sink into recession, politicians, mainstream economists, policy wonks, and the Federal Reserve begin beating the economic stimulus drum.

Politicians, however, disagree over the type of stimulus to implement. The center-left party proposes greater expenditures on public assistance programs. The center-right party supports permanent tax rate reductions. The center-left party opposes tax cuts because they say it benefits the rich. The center-right party opposes raising government expenditures because it increases government debt. This discord generally results in a temporary compromise where government expenditures are boosted and tax rates are cut. This compromise is called “discretionary fiscal stimulus.”

While the debate over discretionary fiscal stimulus has to overcome Senate filibusters and heated House debates, the central bankers at the Fed quickly implement monetary stimulus. Boosting aggregate demand is the intended purpose of it and discretionary fiscal stimulus. In mainstream economic theory, greater aggregate demand lowers unemployment and raises GDP. In spite of grave warnings from Austrian-school economists, the Fed pursues these goals by lowering interest rates via an expansion credit.

Although the political parties disagree over the type of fiscal stimulus to implement, both support the Fed’s monetary stimulus. Perhaps they do so because lower interest rates lower the cost of the budget deficits their discretionary fiscal stimulus produces. The lower interest rates also reduce the interest Americans pay on their debts. The total of this debt is unevenly distributed across the richest 1 percent, the next 9 percent, and the bottom 90 percent of Americans (as ranked by wealth), according to the following table.

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Total household debt averaged $11.295 trillion dollars over the four quarters in 2013, according to the Federal Reserve Bank of New York. Multiplying this value by the percentages in the above table indicates that the richest 1 percent, the next 9 percent, and the bottom 90 percent have aggregate debts of $610 billion, $2.383 trillion, and $8.302 trillion, respectively. These values are listed in the Total Debt column below.

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The table above summarizes a thought experiment that measures the reduction in annual interest paid by each group at two different interest rates, 5% and 1%. The richest 1 percent, the next 9 percent, and the bottom 10 percent pay $30 billion, $119 billion, and $415 billion in annual interest payments, respectively, at a 5% rate of interest. At 1% interest, the corresponding annual interest payments decline to $6 billion, $24 billion, and $83 billion.

Column DI reports the decline in total interest paid by each group that results from the interest rate declining from 5% to 1%. The bottom 90 percent, as a group, receive the lion’s share of the savings. After the interest rate is lowered, the group’s aggregate annual interest payment declines by $332 billion. The savings to the richest 1 percent is only $24 billion.

The above results suggest that the bottom 90 percent benefit mightily from a decline in interest rates. However, this is misleading because there are 98.9% more people in the bottom 90 percent than there are in the top 1 percent.

According to the U.S. Census, there were 117 million households in the US between 2011 and 2015. This means there were about 1.17 million households in the richest 1 percent, 10.5 million in the next 9 percent, and 105.3 million in the bottom 90 percent. Dividing the values in the above table’s final column by the number of households in each group gives the reduction in annual interest payments for each household in each group, assuming the households in each group are equally wealthy. The per household annual windfalls for each group are $20,852 for the richest 1 percent and just $3,154 for the bottom 90 percent.

Investment compounding makes the disparate benefits from the decline in interest rates even more disparate. For most households in the bottom 90 percent that live paycheck to paycheck, their $3,154 windfalls are likely being used to repair their cars, cloth and feed their kids, or purchase consumer goods. Members of the top 1 percent who reinvest their $20,852 windfalls can grow this stream of payments to just over a quarter of a million dollars in 10 years at an annual rate of just 4%.

The above thought experiment illustrates that central bank interest rate cuts are essentially tax cuts for the rich. To be consistent, those who oppose tax cuts for the rich should also stand against monetary policy that disproportionately benefits the richest households as well.

Hal W. Snarr is an assistant professor of economics at Westminster College in Salt Lake City, Utah.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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