The asymmetry of zero rate programs: when rates are cut that hurts retirees who get most of their income from bond yields. It also destroys the consumer confidence of retirees. When people close to retirement age feel they can’t earn enough yield to afford to retire then they will refuse to retire, thus hoarding jobs needed by young people, which increases the supply of labor, thus suppressing wage growth. This is deflationary.
When rates are cut the nature of amortized debt means that the payment doesn’t decline as much as one would think because as rates decline the amortization of principal increases, so the total payment doesn’t go down as much as if it were an interest-only loan. Also, lower rates aren’t a huge help in persuading businesses that a proposed new project exceeds its hurdle rate since much of the hurdle rate comes from risk premium instead of the cost of debt.
The benefits of zero interest rate programs (ZIRP) are less than the detriments. A constantly and capriciously fluctuating interest rate set by the central bank creates contingent risk for capital allocators who are then forced to add a risk premium for unknown future problems caused by central bank interest rate manipulation. This makes the cost of capital higher, thus suppressing economic growth. The rate that determines economic growth is the hurdle rate, not the interest rate; the Fed’s tampering and imposing ow rates can only result in the hurdle rate going higher, which has a deflationary result.
The actions of central banks to bail out investors results in Morale Hazard where investors are then encouraged to take on too much risk since they are led to believe that downside risk has been greatly reduced. This results in even bigger crashes requiring even bigger systemic bailouts. This is somewhat like a “Minsky Moment” when the existence of calm conditions may fool people into investing recklessly, leading to a crash. Thus the central bank’s actions of bailing out bubble makers ends up creating even more risk and volatility. This in turn makes it harder for consumers and businesses to plan and commit to capital allocation projects, thus depriving the economy of much needed economic growth.
The best way central banks can help the economy to grow is to avoid rocking the boat with bizarre, unreliable, untried, disruptive programs like QE and to avoid panicking and cancelling the Fed’s tapering of QE in June, 2013 (so they should have continued the tapering). Now they have unofficially ended QT after only 1.3 years and after only selling off 4% a year of the bonds they bought during QE, which is roughly what a mid-term bond portfolio’s runoff rate could be. Thus they made very little progress in QT, demonstrating behavior like a repeat of the anti-taper policy of 2013.
A market melt-up by naïve speculators is possible if they incorrectly leap to the conclusion that low rates will make stocks go up. But the macroeconomic tide of a once in ten year cycle implies this year there will be a recession, now that tax cuts stimulus has faded away and lost credibility. The fundamentals such as macroeconomics are stronger than technical or emotional items like being manipulated by low rates, so I expect that stock market bears will be vindicated this year.
Investors need independent financial advice about the risks of a deep stock crash and a plunge in rates.