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What will lift deposit rates first: inflation or growth?

by Scarlett Vasquez
Money Rates Columnist
September 23, 2013

This is the first installment of MoneyRates.com's Money Perspectives series, in which a panel of academics offer insights on economic issues.

If you depend on interest from a savings account for part of your income, the historically low interest rates of recent years have likely posed some challenges for your finances. For thoughts on what could end this era of ultra-low interest rates, these professors answer the question:

What will drive deposit rates higher first: economic growth or inflation?

Bill Watkins

Cal Lutheran

Bill Watkins, Ph.D., Associate Professor and Executive Director at California Lutheran University’s Center for Economic Research and Forecasting

Inflation can't happen without bank lending. So, bank lending, and hence economic growth, must occur before we see inflation. Increased economic activity will increase real interest rates. Inflation will cause an increase in nominal interest rates, but real interest rates could decline.

Maclyn Clouse

University of Denver

Dr. Maclyn Clouse, Sorensen Distinguished Professor of Finance at the University of Denver’s Daniels College of Business

I don’t expect either one to have much of an immediate impact. Economic growth is still slow and inflation is still low. Most banks have more deposits than they need. There is no reason to increase rates to attract more deposits until there is more loan demand, which may finally happen if we see faster economic growth.

Nathan GraweCarleton CollegeDr. Nathan Grawe, Associate Professor of Economics at Carleton College

In the short run it is likely to be growth that drives rates higher because the depressed economy will keep a lid on inflation. (The spread between inflation-indexed bonds and constant maturity bonds shows no hint of unusual inflation on the horizon, either.) But when the economy begins to improve, then we have a real question of how the Fed will unwind its balance sheet. For each time we heard the Fed was expanding its assets in an unprecedented way, we face a future moment when the Fed will have to sell off unprecedented assets. With the balance sheet five times as large as it was at the start of the crisis, we are sitting on an incredible amount of potential monetary stimulus.

Alan CarperBob Jones UniversityAlan Carper, Professor at the Bob Jones University School of Business

Economic growth. Based on the Fed’s recent actions, which are consistent with its primary goal of keeping inflation in check, I believe if deposit rates rise in the near-term, it will be due to economic growth fueling demand for loans and a greater need for deposits.

Bradley StevensonBellarmine UniversityDr. Bradley Stevenson, Assistant Professor of Finance at Bellarmine University

Economic growth will drive deposit rates higher first. The Fed’s main objective is to control inflation and based on past history they have done an effective job of carrying out that objective. Thus, any increase in rates should be primarily due to an increase in economic growth.

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