Do lower rates hurt savers?

 Savers looking for higher interest incomes must wait longer with economists embracing models that suggest only a section of them lose out in a lowerrate regime, but a large chunk of savers gain due to higher economic activity.

Reserve Bank of India (RBI) executive director Mridul Saggar says the argument that lower rates hurt savers across the board doesn’t hold water. “The frontier of the macroeconomics, especially in terms of Heterogeneous Agents New Keynesian (HANK) models, provides a good reason to think that not all savers may necessarily be worse off when central banks push down the interest rates,” said Saggar in the monetary policy committee’s (MPC) June meeting
Such models capture diverse effects of a central bank’s rate action. The conventional understanding is that the falling returns on account of lower interest rates work as a disincentive for a saver. But that may not hold on all occasions.

“As demand increases with monetary expansion, firms ramp up production. This improves their survival rate amid a deep shock like the pandemic. It also protects job losses and pushes more wages and salaries in the hands of households, most of whom may get more than compensated for a drop in their interest incomes on savings,” explains Saggar

Put simply, soft interest rates provide an opportunity for more output and job generation making up for the loss in interest income, the theories suggest. “Savers by definition are worse off if their savings are in fixed income instruments like FDs. However, in the middle of a shock, there is a strong case to keep rates low because of the expansionary effects it has on incomes,” said Abheek Barua, chief India economist at HDFC Bank. “This is particularly true of individuals and firms that are liquidity constrained. Public debt created through fiscal expansion becomes more sustainable if interest rates are low. These second-round benefits are likely to outweigh the erosion of savers’ incomes when the economy faces a deep shock.”

These multiplier effects justify rate cuts and monetary and liquidity accommodation, according to Saggar.

The RBI lowered the policy repo rate by 115 bps (one bps in 0.01%) between September 2019 and September 2020 prompting banks to lower deposit rates as well, though not proportionately. But household financial savings rose to 10.4% of GDP in September 2020 from 9.8% a year ago.

“Also, reduction in interest rates may benefit those with savings in equities through higher asset prices,” said Rahul Bajoria, India economist at Barclays Capital. “At the same time, capacity creation may also act as a positive offsetting factor, but the time it takes for demand revival may be critical to gauge whether the savings impact is large or small, cumulatively."

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Put simply, soft interest rates provides opportunity for more output and job generation making up for the loss in interest income, the theories suggest.

Synopsis

Economists are embracing models that suggest that only some savers lose out but a chunk of them gain through higher economic activity. RBI Executive Director Mridul Saggar says that the argument lower rates hurt savers across the board doesn't hol...

By Gayatri Nayak, ET Bureau

Jun 21, 2021, 09:05 PM IST

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Savers looking for higher rates of interest can give up hope for sometime as the belief that all savers do not lose in lower rate regime is gaining ground. Economists are embracing models that suggest that only some savers lose out but a chunk of them gain through higher economic activity. RBI Executive Director Mridul Saggar says that the argument lower rates hurt savers across the board doesn't hold water.

" The frontier of the macroeconomics, especially in terms of Heterogenous Agents New Keynesian (HANK) models provide a good reason to think that not all savers may necessarily be worse off when central banks push down the interest rates" said, Sagar in the monetary policy committees June meeting.
Such models capture diverse effects of a central bank's rate action. Conventional understanding is that the falling returns on account of lower interest rates works as a disincentive for a saver. But that may not hold on all occasions. " As demand increases with monetary expansion, firms ramp up production. This improves their survival rate amid a deep shock like the pandemic. It also protects job losses and pushes more wages and salaries in the hands of households most of whom may get more than compensated for a drop in their interest incomes on saving" explains Sagar
Put simply, soft interest rates provides opportunity for more output and job generation making up for the loss in interest income, the theories suggest. " Savers by definition are worse off if their savings are in fixed income instruments like FDs However in the middle of a shock, there is a strong case to keep rates low because of the expansionary effects it has on incomes" said Abheek Barua, chief India economist at HDFC Bank. " This is particularly true of individuals and firms that are liquidity constrained. Public debt created through fiscal expansion becomes more sustainable if interest rates are low. These second round benefits are likely to outweigh the erosion of savers' incomes when the economy faces a deep shock"

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These multiplier effects justify rate cuts and monetary and liquidity accommodation, according to Sagar. The RBI lowered policy repo rate by 115 bps(one bps in 0.01 per cent) between September 2019 and September 2020 prompting banks to lower deposit rates as well, though not proportionately. But household financial savings rose 10.4 per cent pf GDP in September'120 from 9.8 per cent a year ago

" Also, reduction in interest rates may benefit those with savings in equities through higher asset prices" said Rahul Bajoria, India economist at Barclay's Capital. " At the same time, capacity creation may also act as a positive offseting factor, but the time it takes in demand revival may be critical to gauge whether the savings impact is large or small, cumulatively"
But Saggar also warned that prolonged negative interest rates carries risks of lower incomes and higher inequity. "I think we may have already crossed over to that point, given the very weak state of our informal sector and overall employment, in sharp contrast to the high asset prices in our equity markets" said Ananth Narayan, associate professor and head of research at SP Jain Institute of Management and Research