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The "New Normal" of Ultra-Low Interest Rates

Tags Money and BanksMonetary TheoryMoney and Banking


After nine years of outrageous, unwarranted and irrational monetary policy, some people are taking the current monetary regime as normal and natural — the new normal. You can see this on corporate ballot sheets, bank leverage, and the low personal savings rate.

However, even the “man on the street” is beginning to believe in this “new normal.” During a recent radio interview, I was attacking the ultra low interest rate policy of the Federal Reserve and other central banks. A caller to the program asked why we shouldn't have very low interest rates. It seemed to be a good idea to him.

He argued that things like oranges are much less expensive today than they were a century ago when adjusted for inflation. If the modern economy produces low prices for oranges and bananas, why can't we have low interest rates too? Why can't we have cheap credit?

I remarked that it was a good question with several good answers. The first answer is that increasing the money supply and reducing interest rates artificially low is unnecessary. In a market economy any supply of money will get the job done. There is no reason to increase the supply of money. Prices will adjust, in that they will decline, so that every dollar has a greater purchasing power. The Mercantilist fallacy, that money is wealth, was exposed almost three hundred years ago, but it’s a lesson still unlearn by the economists working for the Fed.

The second answer is that increasing the supply of money and manipulating interest rates causes instability in the economy. Artificially lowering interest rates sends the wrong signals to entrepreneurs who then make mistaken investments in the economy. These mistaken investments will eventually be revealed, resulting in bankruptcies, foreclosures and job losses. The process of reallocating all of these resources is economically painful and psychologically damaging.

The third answer is that increases in the supply of money and artificially reducing interest rates increases economic inequality in society. You can easily see that on the one hand the people who are already wealthy such as bankers, financiers, and real estate developers are made better off from this monetary policy. On the other hand, low income and middle income people are made worse off, especially if they are trying to save money in order to be better off in the future. Low interest rates discourage personal savings and reduce the value of your savings.

Economic historians have long known that inflationary monetary policy is harmful to labor and benefits capital. Economist Thomas Piketty found that economic inequality has increased in the United States in the twentieth century. However, economic inequality in the United States actually declined until 1971. All the increase in economic inequality occurred after 1971 when President Richard Nixon took the country and the world off of the Bretton Woods gold standard.1

One argument against the gold standard was that we wasted resources in order to mine gold for coined money. Milton Friedman famously made this argument. His argument was that if we substitute paper for gold we would save a massive amount of resources. Plus, Friedman was an avid admirer of Irving Fisher, a famous early twentieth-century economist, who wanted the government to “scientifically” manage the money supply and the value of the dollar.

Their arguments have turned out to be utterly false. History has shown that paper monetary systems create bigger problems with price inflation and business cycles. As I mentioned above, inflationary monetary policy creates economic instability and malinvestments associated with the business cycle. This involves investment losses, conversion costs, and labor time lost in between jobs.

It also involves allocating large amounts of resources to companies that would otherwise be unnecessary. For example, there has been a large increase in the number of companies and the amount of labor in the American financial sector. There has also been a huge increase in the number of firms involved in consumer credit. The size of the financial sector in the United States has increased from about 4% of the total economy when we were on the gold standard to more than 8% since we went off of the gold standard.

With a gold standard people can save for the future by depositing money in bank account with no or little risk. People earn interest on deposits, compounding over time, and with a likelihood that the purchasing power of each dollar will appreciate over time. There is little need in this world for sophisticated financial advice and complex investment options, but there is in our world of negative real interest rates and a constantly depreciating dollar.

It is also the case that with a free market economy on a gold standard, it is very likely that interest rates would indeed be very low.

Finally, the opportunity cost of mining gold — to hoard, rather than coin — has actually increased, and not decreased as promised by Friedman. Gold hoarding has not been eliminated at all by switching to paper. Central banks and governments still hold fast hordes of gold. Firms, mutual funds, electronically traded funds, i.e., ETFs, hold enormous amounts of gold and silver and individuals also horde vast amounts of gold and silver in bank safety deposit boxes as insurance against risk.

The Mercantilist fallacy is unfortunately still alive and thriving, most especially at the Federal Reserve. Rest assured that the “new normal” is actually the old myth that money is wealth.

  • 1. This was not the classical gold standard, but did tie the dollar to gold for international transactions. 

Contact Mark Thornton

Mark Thornton is the Peterson-Luddy Chair in Austrian Economics and a Senior Fellow at the Mises Institute. He is the book review editor of the Quarterly Journal of Austrian Economics, and has authored seven books and is a frequent guest on national radio shows.

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