BUSINESS
09/09/2010 11:49 am ET | Updated May 25, 2011

How The Fed's Low Interest Rate Policy Is Hurting Savers, Retirees

With the Fed's key interest rate approaching zero, there's rarely been a better time to borrow. It happens to be a particularly bad time to save, however.

The New York Times reports that the average interest on deposit accounts was 0.99 percent in July, the first time it's gone below one percent since the 1950s.

For that, you can thank the Fed's longstanding low interest rate policy, which has brought banks' quarterly cost of funds to a 26-year low but hasn't resulted in a boom in lending. Historical records on commercial banks' cost of funds going back to 1934 show that the last time banks paid less than one percent for the year was 1960.

As a result, savers have been put in a bind. Whereas three years ago it made sense for retirees to live off annual interest from a standard certificate of deposit, that's now nearly impossible. The highest rates these days, the NYT notes, are around 1.5 percent, yielding only $7,500 a year on a $500,000 deposit, compared to rates above five percent in 2007.

The low rates are supposed to stimulate growth, the idea being that both people and corporations would borrow money and spend their way out of debt and out of the recession.

But if the Times' men-on-the-street are any indication, the low rates can actually have the opposite effect. Retired AT&T engineer Marcel Lonneman said his colleagues are reluctant to take out loans because they think the rates will fall still further. It's analogous to the evils of deflation, when people don't spend money as they wait for prices to hit bottom.

The Bank of England, too, is keeping its interest rates low. Typically, the fear associated with low interest rates is inflation, but now, terrifyingly, that's not what's on people's minds. Back in 2008, Paul Krugman warned of ZIRP, or zero interest rate policy, in which low interest rates accompany a stagnant economy.

People have been talking about deflation for a long time, but now it looks like one of the Fed's main weapons against it-- low interest rates --is not only doing nothing for the economy, but also hurting people who've diligently saved their money.

Still, Dallas Federal Reserve Bank president Richard Fisher fears not deflation but inflation. He writes in the Wall Street Journal that the Fed has done all it can, and that it's up to regulators and the government to whip the economy into shape. The real problem, he says, is that businesses are sitting on money rather than spending it.

Back in July, Reuters' Felix Salmon warned of the same problem. If businesses are afraid to borrow, the low interest rate isn't necessarily going to help.

As Federal Deposit Insurance Corporation Chairman Sheila Bair said last week, "Consumers and businesses need to have confidence in the recovery before they will start making decisions on credit."