When Prices Go Down, Consumption Increases...Right?

A debate in The Economist on the cause and effect of low interest rates recently caught our eye. Michael Spence and Kevin Warsh of Stanford argue that low interest rates have harmed consumption rather than bolstered it. The Fed’s QE programs, which have pushed down rates and helped to increase stock prices, have caused business and long-term investment to fall. Their rationale is that stocks and bonds increasing in price in the short-term is more appealing than long-term “real economy” investment, like home purchases or capital investment. The Economist takes the other side, arguing that low rates tend to stimulate demand, not lower it. The article paraphrases Joseph Gagnon of the Peterson Institute, who observes, “It is weak spending and investment that is keeping interest rates low, not the other way around.” 

Our view is that the real reason rates remain low is flagging demand. Rates have needed to come down to entice investors to take action, and low rates remain a catalyst for consumption.  So as the Fed prepares to raise rates in the coming months, the question becomes how the real economy will react.  The answer remains to be seen.

Sources: The Economist, Fiscal Times, SNWAM Research