Fed's Low Interest Rate Strategy Is Killing the Incentive to Earn and Save

Here Cato Institute Senior Fellow Alan Reynolds chronicles the soaring number of Americans not working due to misguided Obama administration policy.

Federal Reserve efforts to keep interest rates absurdly low have reduced the incentive to earn and save money for the future while encouraging risky debt and dodgy investments. Flattening the yield curve through Fed purchases of long bonds made it less profitable for banks to lend to small business.

The fact that employment has gradually risen from 140 million to 145.7 million since the recession ended is unremarkable. What is truly remarkable is that at the same time that job opportunities improved, the number of Americans who were neither working nor seeking work soared from 80.9 million to 91.4 million.

One economist who understands the importance of work disincentives is University of Chicago economist Casey Mulligan, author of “The Redistribution Recession” (2012), who first blew the whistle on punitive work disincentives in ObamaCare. Another is Nobel Laureate Ed Prescott, who demonstrated on this page (“Why Do Americans Work More Than Europeans?” Oct. 21, 2004) that the people of France are a third poorer than Americans only because they were deprived of incentives to work—by onerous marginal tax rates on excess effort and generous subsidies to indolence.

The demand-side panacea for weak economic growth has encouraged families and firms to spend a larger fraction of their current income and wealth—by using tax and monetary policy to punish savers and reward debtors. A supply-side solution would incentivize families and firms to produce more income and wealth by minimizing unpredictable regulation and litigation, trade barriers, unreliable money and dispiriting tax rates.

Demand-side economists focus on incentives to borrow and spend. Supply-side economists focus on incentives to work, save, invest and launch new businesses. Demand-side economists focus on the uses of income and debt (consumption). Supply-side economists focus on sources of income and wealth.

From the perspective of demand-side bookkeeping, the fact that consumer spending in 2012 accounted for 68.6% of GDP supposedly means economic growth depends on consumer sentiment. Viewed from the supply side—the sources of GDP—private industry accounted for 86.5% of GDP. If private businesses had not produced $14.1 trillion, consumers could not possibly have consumed $11.1 trillion. Economies do not grow because consumers spend more; consumers can spend more only if economies grow.

The time for demand-side gimmicks has long passed. The remarkably aggressive fiscal and monetary effort to stimulate demand did not stimulate demand. Even if it had worked, we can’t pretend to be “fighting recession” forever. Today’s economic predicament is not a cyclical crisis but a sustained, subsidized lethargy. Different tasks require different tools. When the number of job seekers falls twice as fast as the increased number of jobs, that is a supply-side problem.