A few months ago, my wife and I opened a small savings account for our young children to help teach them the power of saving. Compound interest. All that good stuff.
We talked about taking their pennies, dimes, and birthday checks from family and friends and depositing them down at the local savings institution. It’s always neat to see the coin machine sort all those round pieces of metal in a fraction of the time it used to take me to put them into paper rolls. (There used to be some long rainy days growing up.)
Well, several weeks ago, my son got his first savings account statement. The envelope was addressed to him—always an exciting thing for a second grader. On the savings statement, one line stood out: Interest earned over the quarter: $0.03
Here’s an edited (and somewhat loose) adaptation of what happened next:
Son: Three cents, Dad! That stinks!
Father (me): Well, that will compound over time. You see…
Son: But that will take me, like, five years to earn enough money for a pack of baseball cards. Why can’t I earn more?
Father: A lot of people are out of work. They need money. Because the economy has been so weak, the Federal Reserve has kept interest rates close to 0%.
Son: Who is the Federal Reserve?
My wife: A group of economists, like Daddy.
Son: Ohhhh … [long pause, puzzled look at me]
While this story is somewhat amusing, today’s near-zero interest rates are no laughing matter for many American savers—not just my kids. They are my parents, my friend saving for a down payment on a home, and my retired neighbors down the street. You may be one of the many Americans trying to live off of your well-earned savings, whether those funds are in money market or checking accounts. In my mind, savers—as opposed to investors—are the proverbial “sacrificial lambs” of monetary policy.
The Federal Reserve has held its interest rate target between 0% and 0.25% since late 2008. Adjusted for inflation, the yield on 3-month Treasury bills is actually negative, as illustrated in the chart below. Quite frankly, yields on such savings vehicles are likely to remain that way for some time, with the Fed expected to keep its target rate near 0% at least for another year—and possibly longer.
Now, to be fair, the return on savings, or “cash,” has generally been low historically when adjusted for inflation. In some ways it should be low, as cash instruments such as Treasury bills are considered less risky than investments (whether they be stocks, bonds, commodities, or real estate), which have much greater potential for principal loss and gains. Greater risk, greater expected return.
Of course, economics is all about incentives, and policymaking is all about tradeoffs. Given the high level of U.S. unemployment, economists will tell you that short-term rates paid on savings accounts should be low in order to help stabilize and stimulate the economy (and yes, incentivize some savers to become investors). In many ways, the Federal Reserve’s near 0% interest rate policy is aimed at counteracting the “paradox of thrift”—which is, you want everyone to save more, just not everyone at the same time.
But as accommodating as the Fed’s policy has been on the whole, the parent in me feels it is important to acknowledge the price paid by savers during this period. Since December 2007, personal interest income has declined by close to $100 billion. The modest economic growth the nation has experienced since 2008 has come, to some extent, at the price of a negative real rate of return for savers.
While some investors view the prospects of higher interest rates at some point in the future with apprehension, I know two children that will welcome that day. I suspect that they will not be alone.
Treasury bill yields, 1955–2011
Sources: Federal Reserve, U.S. Bureau of Labor Statistics, and Vanguard.