Out of the view of the general public, but increasingly discussed in wonkish circles, is the Federal Reserve's difficulty in raising interest rates back to sustainable levels. As this drama unfolds, Utah consumers should resist the increased temptation to take on unwise debt for wants or pleasures rather than prudent investments. As we learned in the 2008 financial crisis, prodigal lending and undisciplined borrowing is a recipe for financial disaster.
Ever since the Great Recession, when the Fed aggressively lowered interest rates in an attempt to stimulate the economy and avoid a worsening economic depression, the federal funds rate has remained stubbornly near 0 percent.
For consumers and governments, low interest rates present compelling enticements to borrow and spend more than they otherwise would. Disciplined borrowers can benefit significantly from lower interest rates by retiring debt faster and reducing their interest expense. However, history suggests that most borrowers are not that disciplined, and low interest rates create an almost irresistible temptation to borrow for nonessential “wants” or luxury "pleasures."
One manifestation of low interest rates is the advent of the cash-back credit card. For many people, buying groceries with cash is now more expensive than buying groceries with credit, because they can get cash back for their credit card purchases. Many consumers are jumping on this bandwagon, since it is like borrowing with negative interest rates. However, failing to pay off the balance each month, or incurring a single late fee, can incur interest and fees that exceed any potential for savings.
The pattern of undisciplined borrowing is clearly evident in the recent behaviors of both consumers and the government. Since the end of 2008, consumer debt has not only recovered but is 38 percent higher. During the time the federal government's debt load has doubled, adding more than $7 trillion.
Why has this increase in debt not crippled consumers and the federal government? One explanation is that lower interest rates allow for more borrowing without more debt service. One example of this effect is in Europe, where Germany is able to borrow money at negative interest rates. The magic of negative interest rates is that as borrowing increases interest payments decrease. It’s great for governments and those who tend to borrow a lot, but it is bad for banks and other institutions that lend.
The justification for the Fed setting interest rates low is simple. When the cost of money is down, people and businesses tend to spend more, which stimulates the economy. At some level, this is good for borrowers as well as the economy in general. However, when the stimulus effect wears off, the low rates can lure consumers into inappropriate purchases and debt accumulation, which in the long run bankrupt businesses and individuals and harm the economy. The Fed and others are clearly concerned that the risks associated with low interest rates are beginning to outweigh the benefits.
While rates remain historically low, Utah consumers should resist the strong temptation to borrow for superfluous spending.