The Federal Reserve has been accused of raising interest rates too quickly over the past couple years, but a better case can be made that they've kept rates too low for too long.
Depositors in U.S. banks have seen consistently low yields fail to keep up with inflation and, as a result, their deposits have lost more than $1.5 trillion in purchasing power since the financial crisis.
For a decade now, MoneyRates.com has studied the hidden cost of drastically low interest rates implemented by the Federal Reserve in reaction to the Great Recession. Not only was this cost borne most heavily by people with bank savings, but that cost has continued even though that recession ended nearly ten years ago.
How Fed rate policy cost depositors over $1.5 trillion
Historically, even depositors with short-term deposits like savings accounts, money market accounts and short-term CDs could expect to earn a sufficient interest rate on those deposits to stay ahead of inflation. There were short periods where this wasn't the case; but generally speaking, deposit rates exceeded inflation and thus preserved the purchasing power of those deposits.
Things changed radically when the Fed implemented its extreme low-interest-rate policy in response to the Great Recession. For nine of the past ten years (through March 31, 2019) short-term deposit rates have failed to keep up with the prevailing rate of inflation. That means that deposits in U.S. banks have lost purchasing power over the past decade, to the tune of $1.5 trillion.
To calculate this, MoneyRates looked at inflation rates from the Bureau of Labor Statistics plus figures on total deposits and average money market rates from the FDIC. Money market rates were chosen as a measure of deposit rates in general because they are higher than savings and very short-term CD rates but lower than long-term CD rates. While the Fed does not directly control bank money market rates, its policies influence U.S. interest rates in general and in short-term interest rates in particular.
As of March 31, 2018, there were $12.257 trillion in U.S. deposits at FDIC-insured banks. Over the subsequent 12 months, money market rates averaged 0.14 percent while inflation rose by 1.9 percent. This resulted in those deposits losing $225 billion in purchasing power in just that one year.
In fact, not only have deposits continued to lose purchasing power, but the past three years have seen the three deepest losses of the ten-year period examined. Total purchasing-power losses of U.S. deposits have exceeded $200 trillion in each of the last three years, making those three years responsible for nearly half the total loss of purchasing power over the past ten years.
These losses of purchasing power have come despite the Fed beginning to raise rates over the past three years. With inflation starting to perk up, the Fed has not been too aggressive in raising rates but, rather, has acted too slowly to help long-suffering depositors.
Boon to borrowers led to record debt levels
Often in economics where one group suffers another group benefits -- and, in this case, the beneficiaries of low interest rates have been borrowers. Historically, low interest rates helped fuel a recovery in the housing market and the economy as a whole. The bad news is those low interest rates also encouraged a borrowing binge that has led to record amounts of mortgage, credit-card, car-loan and student-loan debt outstanding.
The irony is that the Great Recession was caused in part by excessive borrowing. The Fed's response has helped encourage even greater levels of borrowing while it served to punish savers.
>> How much revolving debt is there? Read Rising Interest Rates: Consumers Face Unprecedented Risk
How to earn better rates
You can't do anything about Fed rate policy, but you can take steps to minimize the damage low interest rates have on the purchasing power of your deposits:
1. Shop for the best rates - you can probably do much better
As of March 31, the FDIC showed the average money market rate at 0.18 percent. In contrast, the MoneyRates.com America's Best Rates survey found a few leading money market rates above the prevailing 1.9 percent rate of inflation, and several savings account rates above that level as well.
Smart shopping can make the difference between your deposits gaining or losing purchasing power.
2. Consider a longer commitment to earn higher rates
If you don't need access to your money immediately, you could earn an even higher rate by committing to an intermediate or long-term certificate of deposit. This can give you an even bigger edge over inflation, as long as inflation doesn't rise drastically before the CD matures.
3. Use a CD ladder to balance liquidity with higher yields
To earn a higher yield without committing entirely to a long-term CD, you could construct a CD ladder consisting of a mix of short, intermediate and long-term CDs.
There is little disagreement that the Fed had to take strong action in the financial crisis. The question is: With that crisis almost a decade back in the rear-view mirror, why has the Fed continue to make savers pay a price for a crisis they didn't cause?
More resources on the federal funds rate and the Federal Reserve Board:
Read the latest on Fed meeting recap