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Estimated cost of Fed policy: $635 billion and counting (infographic)

| MoneyRates.com Senior Financial Analyst, CFA
min read

As a result of today's unusually low interest rates, U.S. depositors may have lost more than $120 billion in purchasing power in the last year. That's the finding of a new MoneyRates.com analysis that examines how much today's low deposit rates may be costing American savers.

This new figure pushes the running four-year estimate of lost purchasing power to $635 billion. Since the Federal Reserve is the chief architect of today's low rate environment, depositors may want to ask the Fed a simple question: Why are you doing this to us?

The Fed's answer would be that low interest rates are intended to stimulate the economy by encouraging borrowing. But this strategy has produced only questionable economic results, all while the estimated losses for American depositors have continued to grow. This makes it time for a fresh look at whether this approach is worth its costs.

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Fed vs. your savings infographic

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Hidden losses

For the past four years, MoneyRates.com has measured the hidden cost of the Fed's low-interest-rate strategy. The approach is very straightforward. Historically, short-term interest rates have usually been a little higher than the inflation rate. But in recent years the Fed has helped force interest rates below the level of inflation. This affects the rates on certificates of deposit, money market accounts and savings accounts -- some of the major sources of interest for ordinary Americans.

Starting with the $8.8 trillion on deposit in U.S. banks at the end of the first quarter of 2012, MoneyRates.com calculated how much this would have earned in interest over the next 12 months, using monthly average money market rates from the FDIC. Then, the value of these deposits, plus that interest, was adjusted for inflation to measure the total change in purchasing power over the past year.

The resulting estimate was that American savers lost $120.1 billion in purchasing power over the year ending March 31, 2013. Perhaps the silver lining was that this was less of a loss than the estimated $205 billion in purchasing power lost over the previous 12 months. However, this wasn't because interest rates had recovered during this period -- in fact, they were lower than ever. The damage was reduced simply because at 1.5 percent, inflation was unusually mild over that 12 months.

The Fed's reasoning

The Fed has a very compelling reason for its extraordinary measures to reduce interest rates: It wants to bring down the unemployment rate. Also, reducing interest rates helped stabilize both the banking system and the real estate market, which were both on the ropes in 2008 and 2009.

The Fed may have the right intentions, but how effective has its low-interest-rate strategy been? The results are a mixed bag. While unemployment has come down, it has done so at an agonizingly slow pace, falling to just 7.5 percent as of April. Over 65 years of unemployment data from the Bureau of Labor Statistics, this is the highest the unemployment rate has been this far into an economic recovery.

As for the banking system and the real estate market, it remains to be seen whether the stability of either will survive a return to more normal interest rate levels. In short, the results of the Fed's efforts currently fall somewhere in the range between disappointing and inconclusive.

Mounting criticism

Though one would be hard-pressed to argue with the goal of reducing unemployment, the Fed's low-interest-rate approach has drawn increasing criticism, and only partly because it doesn't seem to be working very well. Here are three potential problems with the Fed's attempt at economic stimulus:

  1. Pushing on a string. Making it cheaper for people to borrow money makes sense if there is strong demand for borrowing, but with a weak employment market and many consumers already struggling with debt, that demand is limited at any price. Applying stimulus to an unresponsive area is known to economists as "pushing on a string," and the results suggest the Fed's policy may be an example. The economy has been on a virtual flat-line over the past three years, with real gross domestic product growth of 2.4 percent, 1.8 percent, and 2.2 percent for 2010, 2011 and 2012, respectively.
  2. Pouring gasoline on a fire. Some would argue that the Fed's policy has been worse than ineffective -- it has been dangerous. After all, the Great Recession and financial crisis were largely caused because of debt problems. Under those circumstances, trying to stimulate the economy by encouraging even more debt may seem like pouring gasoline on a fire. Back in 2008, American consumers owed more than $2.5 trillion in outstanding credit. Now, that figure has swelled to $2.8 trillion.
  3. Creating asset bubbles. The stock market may have responded positively to low interest rates, but that's a risk as well as a benefit. A stock rally that has been fueled more by low interest rates than by earnings growth can just as readily head south when interest rates return to more normal levels. If the recent rally in housing prices is equally dependent on unnaturally low interest rates, the Fed may now have a stimulus program it can't easily stop.

All of this aside, the Fed's low-interest-rate policy has produced mixed results in its primary goal of stimulating the economy. When those results are measured against an estimated $635 billion in lost purchasing power, it's fair to ask whether the U.S. economy would have been better off with that money in the hands of consumers.

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