Bernanke’s ZIRP and Consumer Spending

To adherents of the Austrian school of economics, the zero interest rate policy (ZIRP) of Federal Reserve chairman Bernanke presents a myriad of problems. In this post, I would like to mention one particular problem. Bernanke claims that ultra low interest rates will spark a rise in consumer spending via the “wealth effect“. For the sake of argument, let us assume that the psychological wealth effect is true, meaning that people feel wealthier due to rising nominal values of assets such as stocks and houses. Let us also assume that Bernanke’s ZIRP is actually able to achieve this effect. Furthermore, let us assume that increasing nominal consumer spending is a “good thing” in and of itself, regardless of what causes it. Despite these assumptions, we are still left with an enormous gap in the chain of logic of ZIRP -> wealth effect -> increased consumer spending -> positive economic outcome. The problem I will consider is the link from wealth effect -> increased consumer spending.

If consumers perceive an increase in the worth of their assets, will they necessarily increase their consumption? The answer is clearly no. Under some circumstances, they may increase spending on consumer goods, but under other circumstances they may increase their cash holdings, investments, or pay off debt. There is no reason whatsoever to assume that an actual increase in wealth will in all cases lead to an increase in consumption. What is done with such an increase in wealth will depend on the particular circumstances of the individual and those of the society in which he resides.

Thus, we see that since Bernanke, being a good Keynesian and believing that our present economic woes are due to a lack of aggregate demand, has embarked upon the ZIRP to solve this perceived problem via the wealth effect but he has no valid reason to believe that he is guaranteed to succeed. What is more troubling is that I would argue that the personal debt problems of the general public plus the lack of savings of impending retirees plus grotesquely low interest rates combine to make it highly unlikely that consumers will be in the mood to increase real [1] spending any time in the near future. I think that it is far more likely that people will continue to pare down debt and add to their retirement savings while cutting spending for necessities and foregoing luxuries. It is quite ironic that the abysmal yields on financial assets caused by Bernanke’s ZIRP requires that people increase their savings rate and decrease consumption, thus counteracting his professed goal of increasing consumption spending. Apparently, Bernanke is unaware of the warnings issued by Bastiat over 150 years ago regarding the unintended consequences of policy actions.

[1] I emphasize that spending in real dollar terms is the important consideration rather than nominal dollars. The government’s consumer price index (CPI) is a politically manipulated number that no sensible person takes seriously (I will leave aside the chimera of the concept of a price level). The Bureau of Labor Statistics reports that CPI is 2.7%, while John Williams of ShadowStats.com reports a value of about 6%. Thus, we see reports of increased consumer spending which may be true in nominal dollar terms, but may represent a decrease in spending in real dollar terms.

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