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The $749 billion price tag behind Fed policy

MoneyRates.com Senior Financial Analyst, CFA
April 24, 2015

The good news for depositors today is that bank account yields have outpaced inflation over the last 12 months -- a rare event since the Great Recession. The bad news is that this improvement barely made a dent in the estimated $749 billion dollars in purchasing power that these depositors have lost to low interest rates over the last six years.

Those numbers are according to new research from MoneyRates.com that measures the estimated impact of the Federal Reserve's low-interest-rate policy on American savers. The study finds that while recent weakness in inflation helped depositors gain some real value from their savings, the estimated running cost of low interest rates remains at nearly three-quarters of a trillion dollars.

Calculating the cost

The Federal Reserve drastically lowered short-term interest rates in response to the Great Recession and has kept them low ever since. Those short-term rates affect the interest depositors earn on savings accounts, CDs and money market accounts. Historically, those bank rates have eked out a modest advantage over inflation, but the Fed's policy has kept rates below inflation for most of the past six years.

MoneyRates.com has been tracking how much this low-interest-rate policy has cost depositors over that time, in terms of purchasing power lost because bank rates have trailed inflation. To calculate this, MoneyRates.com starts with the total amount on deposit at U.S. banks as of March 31, per the FDIC. That total is then increased by average money market rates over the subsequent year (also from the FDIC) and then adjusted for the inflation rate over the same period.

The difference between the resulting figure and the original amount on deposit at U.S. banks represents the hidden cost of the Federal Reserve's low-rate policy.

Running quite a tab

The result of this calculation shows how much purchasing power depositors have likely lost due to Fed policy over the past six years. Over that time, Ben Bernanke, Janet Yellen and their party have run up quite a tab. In precise terms, the cumulative estimated purchasing power lost by U.S. bank deposits over that period comes to $749,443,213,010.

This cost needs to be considered in terms of its impact. Low interest rates were meant to stimulate the economy, but to date the recovery since the Great Recession has been like an engine that keeps stalling just as it seems about to get up to speed. With a setback in fourth-quarter GDP and a disappointing job growth number last month, that engine appears to be sputtering yet again. Three-quarters of a trillion dollars is a steep price to pay for an economic engine that runs like a lemon.

It will come as little consolation to depositors that they narrowly beat inflation over the past year, gaining back $8.4 billion of their lost purchasing power. In most contexts, $8.4 billion is a lot of money, but in this situation it chipped just 1.1 percent off the total that had been lost to low rates. Plus, this minor comeback happened not because bank rates got any higher, but because the Consumer Price Index actually declined slightly over the past year.

It might seem that the solution is for the Fed to raise interest rates, and lately they have been signalling that they may do just that in the months ahead. But there's a catch. The Fed has expressed concern that inflation is now too low to be healthy, and wants to see inflation come back to its target of around 2 percent before raising rates.

With money market rates currently at 0.08 percent, a 2 percent inflation rate would set depositors back behind rising prices. Bank rates could ultimately climb past the inflation rate, but not before depositors had lost still more purchasing power.

Outlook for the Fed and rates

Even if inflation gets back to 2 percent or higher, there is no guarantee that the Fed will immediately raise rates. If the economy is sputtering again, the Fed may further delay a change in policy. Also, the stock market and housing industry represent strong constituencies in favor of low rates. Meanwhile, rate cuts by foreign central banks create yet another pressure on the Fed to keep rates low.

To a large degree, the Fed has painted itself into a corner. It has kept interest rates so low for so long that it has set a new precedent. It will be disruptive to change that precedent, and yet it limits the Fed's policy options as the economy approaches the next recession.

There is a fundamental question of whether it is fair for savers to pay so dearly to bail out banks and their borrowers, but perhaps the ultimate question is whether the cost to savers has truly been worth it. With the economy continuing to sputter, growth may have gotten more of a boost from keeping that three-quarters of a trillion dollars in the pockets of people who are in a financial position to spend it. Certainly, those depositors would have liked the chance to try.

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