The Fed Dismisses the Needs of Savers

With a second Obama administration, many expect that the Federal Reserve will continue quantitative easing. This has lowered interest rates, reducing the return from savings. Seniors are particularly hard-hit, because 10 percent of their income comes from interest on savings.

The spotlight is on the Fed because so far Congress has taken no tangible steps to postpone the fiscal cliff, the combination of tax hikes and budget reductions due on January 1. The Congressional Budget Office has estimated that the fiscal cliff will result in a shrinkage in GDP of 0.5 percent in 2013. This week President Obama meets with congressional leaders to attempt to postpone the fiscal cliff, but no one knows the outcome of the discussions.

Bernanke has led the Federal Open Market Committee to QE3, a decision to buy more bonds, in the hope that a further diminution of already record-low interest rates will have a tonic effect on spending. But it is unlikely that such an action will have any palpable effect on the economy after QE1, QE2, and Operation Twist.

Interest rates have been on a rollercoaster over the last decade. In 2002, the federal funds rate held steady at around 1.75 percent. After decreasing to about 1.0 percent in mid-2004, the federal funds rate climbed to a plateau of about 5.25 percent between the summers of 2006 and 2007. However from the end of 2007 to the beginning of 2009, the rates declined to 0.2 percent and below, and have hovered there ever since.

Losers from low interest rates are those who save and who live off of savings. Frugality is punished, and spending, especially on credit, is rewarded. The elderly who have saved money for retirement find that their nest eggs do not produce as much as income as anticipated. As inflation rises, as is has always done after monetary growth, the nest eggs shrink together with the value of the currency.

Data from the Bureau of Labor Statistics show that people 65 and older receive over 50 percent of their income from Social Security and other retirement accounts, and another 6 percent from "interest, dividends, rental income, other property income" alone. In comparison, people ages 35-44, in their prime working years, receive less than 3 percent of their income from such interest-rate dependent sources.

American households, in any income range and in any age range, hold some financial assets. The holdings of financial assets are not limited to simple bank accounts. Some households in every income category hold a portfolio of different financial assets, and some of these portfolios are likely diversified. The pattern of savings is relatively invariant to age and macroeconomic conditions.

Federal Reserve Board data show that the pattern of holdings of financial assets by households did not change substantially between economic good times (2007) and weak times (2010-2011). However, the net worth of families (households) suffered substantially between 2007 and 2010 except for those headed by individuals above age 75.

In 2010, the latest year available, over 90 percent of families in all age groups owned some types of financial assets, including checking accounts, CDs. Retirement accounts, stocks, bonds, pooled investment funds, and cash value life insurance plans.

Other than checking accounts, the largest category of financial assets is in savings accounts, as would be expected from their tax-preferred status. Almost 60 percent of families with heads of household between 45 and 65 own retirement accounts. For Americans over 65, the percentage diminished, presumably because they draw down these accounts during retirement. The largest values are in bonds, pooled investment funds, and retirement accounts.

As Americans get older an increasing share of their income comes from retirement income. Americans 75 and older receive 72 percent of income from Social Security and retirement accounts. The burden of low interest rates and a weakening currency falls primarily on them.

According to data from the Census Bureau, seniors ages 65 and over made an average of $3,154 from interest in 2011, and an average of $31,557 in total income. Thus on average, ten percent of their income came from interest. In contrast, people ages 15-65 earned an average of $1,293 annually from interest, and $41,528 in total income. Only 3.1 percent of income came from interest for people under 65 years of age.

A higher interest rate would have raised the income of seniors by thousands of dollars. I assume the current interest rate is now one percent. At an interest rate of 2 percent, an average senior would have earned $6,300 annually, a difference of $3,000. At a rate of 4 percent, she would have earned another $9,000. At 6 percent, the highest rate in our range, she would have earned $19,000 annually, $15,000 more than now. This is especially important because a substantial share of seniors' income comes from interest-bearing investments.

Of course, weakening the currency with low interest rates is often correlated with higher equity and home prices, as these prices rise in nominal terms. Many seniors also hold equities and homes in their portfolios. Although they lose by not receiving as much interest, this is partly offset by increases in other asset values.

With the uncertainty of tax hikes next year, and burdensome regulations discouraging investment, the economy faces substantial uncertainty. The loose monetary policy pursued by the Fed discourages savings. It is yet another addition to the economy's problems.