So I understand the “fed funds” rate is now the lowest it has been since the Eisenhower Administration. 2% is pretty low, and I can see where it would save the big banks money on those overnight loans:
“Hello…Wells Fargo? Fleet here. Good - everybody’s good. Listen, could we borrow $475 million until tomorrow? Cool! Thanks!”
So of course the banks will pass the savings on to its customers right? RIGHT?
How does all this work?
Phouchg
Lovable Rogue
Basically just like you said. If the banks can afford to borrow Big Money for less, they can afford to lend Little Money for less. Since there are many competing banks, and they all want your business, each one sets it loan rates as low as possible (well, low enough to maximize profits.)
Thus, more people take out loans and buy stuff, which means more people sell stuff, which means more peole make stuff, which means more jobs are created, or so the theory goes.
Yeah, but it can drop too low. Im not sure what happens then.
Well, its nice to know you can get a home loan soon around 5%.
The other objective/benefit of lowering rates is that it makes cash less attractive. The lower the rate is, the less likely institutions are to stay in cash, thus plowing money into equities (which benefits companies and the economy).
Of course the problem is, you can only drop rates so far (0%), then the game is over (or postponed for awhile)…see Japan.
How about negative interest rates?
“Take our money–PLEASE.” 
See Japan? What does that refer to?
Philosophocles, a sale on money?
See Japan refers to the past ten years of Japanese economic problems. The Central Bank tried monetary policy to the point where real interest rates are in fact negative. The situation is somewhat complex but in essence bad fiscal policy, lack of financial reforms in a weak (in fact in many cases effectivly insolvent banking sector) and a whole raft of putting off hard economic medicine has led to a world of shit for Japan.
(All caveats in re my speciality is certainly not Asia and my knowledge of this derives from second hand reporting as in The Economist, China Guy can no doubt give more detials.)
In re the effect of cutting interest rates: if there is not investment going on then cutting interest rates can be a bit like pushing on a string.
Structurally speaking, this recession is quite different from the past say 10-20 years. We had a clear investment bubble which lead to overcapacity. Cutting interest rates may do little to induce recovery in an already highly-leveraged consumer market where consumption was already running ahead or at least neck in neck with income.
Insofar as cutting interests rates leads to lower bank rates (and the effect is indirect, above all when banks fear rising defaults and need to keep retial rates higher to cushion for defaults) lead to lower refinancing costs which in turn may lead to an easier time working off debt-financed consumption and investment, then this is helpful.
However, the current recession, combined with what is clearly a severe demand shock, has all the hallmarks of something best treated by fiscal (direct spending) rather than monetary (interest rate/money supply) policy alone.
A few thoughts here…
When the fed cuts rates. What they are really saying is that the Federal Reserve Bank lowers the Discount Rate. This is the rate at which they loan money to banks. Because banks are competetive, these savings are passed along almost immediately to consumers.
I do think some of these recent rate cuts are a big deal. For a while the fed was lowering rates - but they re still high, because during the boom period of the 90’s they raised rates to try and put the brakes on the economy. Too much growth too fast can be bad for the economy. So, even though the Fed has cut rates something like 10 times recently, only the last few cuts have meant an exceptionally low rate, before they were just getting it back down from the high point where it was.
By the way (shameless plug here) Anyone that can shed some light on my refinancing question please do…
http://boards.straightdope.com/sdmb/showthread.php?threadid=96243
Actually Debaser brings up an interesting point and by way of a slight hijack, I’d like to know:
What the hell IS the connection between rate cuts and long term mortgage rates?
All I ever hear is “Oh Yarster, don’t you know that when the Fed cuts interest rates, that only affects SHORT term rates?” O.k. fine, like I know what the hell that means. So what is the ‘approximate’ connection? Is it that if the Fed drops interest…say…a half point, it makes short term rates drop a half point which makes long term rates drop 1/8 point, or what?
What exact events have to happen to make mortgage rates go REALLY low?
Loans are a function of the bank’s cost of getting money (which is essentially the interest rate, which you can think of as the cost of money for whatever given purpose), their required return and risk.
The Fed Rate indirectly lowers the cost of getting money. That is but one facet in the chain. Among the most important that leap to mind is risk. Presumably in the present economic climate the bank is facing an increased risk of default, and further perhaps some significant percentage of mortgages it holds might be based on over-valued collateral.
Ergo, they face the risk of not being able to recover. So, in order to cover that, the bank has to build in a premium over cost and required rate of return to help fund the risk that Billy Bob Joe’s Dot Com Inflated House in Alexandria or Westchester is not really worth the 5 million USD as per the mortgage and appraisal circa 2000 but now is really worth 2 million at best. Further, Billy Bob Super Click is now belly up and Billy Bob ran through his other funds etc., is leveraged to the hilt. The bank’s gotta think that even though they have collateral, it’s not worth as much as the face value of the mortgage, there is the risk of an expensive court fight etc. etc.
So, bingo, rates do not necessarily go down as much as they might.
Complicated picture, very hard to predict.
oh no, now my savings rate is going to drop too. last time I looked at it it was like 2%. That was a year ago so I can imagine it must be even less soon. there isn’t much incentive to save now.
Hmm. What’s the inflation rate at now? If it’s above 2% (which I’d assume it is), then we’ve already got an effective negative interest rate…interesting.
Actually, to simplify, two factors are critical. One is the interest rate, and the other is money supply. These two go hand in hand.
The Bank of Japan was forced by the politicians to lower the interest rate to zero (or negative), BOJ governor Mieno thought this was a bad idea and reduced money supply. End result is that cost of capital (loans) were real cheap, but no one had money to lend. [Japan has a host of other problems including a fundamental change in their underlying economy, employment, greying population, bad debts ripping through the financial system, increased competition, and going from running a small deficit to a massive one on pork barrel economic stimulus packages.]
The other factor going on is that the banks all believe the Fed cuts are quite temporary. That as soon as the economy starts turning around, the Fed is going to jack up rates as fast as they have cut them to head off inflation. Remember, the Greenspan Fed is an inflation hawk (as stance I agree with). It took Greenspan years to handle the Volker Fed leftover inflation and Greenspan certainly does not want to reignite inflation.
I can’t get historic numbers out, but here is a link to the current yield curve. http://www.bloomberg.com/markets/C13.html?sidenav=front Historically, it is very steep (I’m going off memory and not data here, so please correct me) with about a 250 bps spread between the 2 and 30 year bonds. What this means is that the short term rates are at something like 40 year lows, but the long term rates that your mortgage is based on has not fallen nearly as much. anyone out there have historic numbers showing the spread between passbook savings rates and mortgages?
To answer the OP, this is not a big deal. Only a marginal change. Look at it this way, you’re a business and need to make a big capex investment for your future. The difference in borrowing money at 8% and 5% is huge. The difference between borrowing money at 5% versus 4.5% is relatively small. It is like saying that an investment does NOT make sense at 8% but does make business sense at 5%. That’s a 300 bps difference and very significant. However, if you drop loan rates from 5% to 4.5%, how many ADDITIONAL borrowers are going to come out of the woodwork that didn’t already get a loan as rates fell from 8% to 5%. So, 50 bps now doesn’t make a big difference.
Link to some historical graphs showing some of the data China Guy is talking about. (Be careful in reading the graphs, they are all on different timelines.)
Eh? How peculiar. How’s the BOJ structred? Money supply as broad or narrow measure?
I’ve read that much of the spending was not mere pork-barrel but stunningly useless pork barrel which never had a chance of adding value.
Or in the alternative, are pricing in a degree of inflation risk in the event that the Fed is slow.
I think to be fair one has to note that the Volker Fed marked the ‘return’ or start of inflation hawkish policy, as per the 1980 recession.
Fair comments Collounsbury. You are very correct in the assumption that the so-called economic stimulous packages announced like clockwork every 6 months since 1992 (or ws it 93?) added very little in the way of productive assets. Just a giant waste of money, and at least half of these economic stimulous packages were just creative accounting. There are more construction firms now than there were at the peak of the Japanese bubble thanks to government contracts. I don’t have figures available, but the Japanese government went from very little debt in 1990 to significantly high levels now.
Off hand I can’t remember the BOJ set up. IIRC it was the broad money supply M3 that the BOJ controlled. I left Swiss Bank Corporation Japan in 1994 and shifted focus to the rest of Asia out of Hong Kong, so don’t quote my numbers as they are ballpark.
Collounsbury has it pretty right, as do many others here.
Short-term rates can drop to nothing, but your long-term {15-30 year) house mortgage will not drop as much because of the long-term risk factor.
Loans which are tied to the “Fed funds rate” or “prime rate” will, indeed, drop. But only as long as the current recession exists.
Will the banks pass along the savings to their customers. As s-l-o-w-l-y as possible.
As a note to people interested in history–during the depression, the banks in the US paid 0 per cent interest on your savings. But they would keep your money in the bank as a service to their customers. Not illogical.
Why would you pay interest on money when no one wanted to borrow the money you had? Essentially the situation in Japan today.