Are Low Interest Rates a Good Idea?

The United Kingdom has artificially kept its interest rates extremely low for the past five years at 0.5%. The reasoning is that low interest rates will help people cope with the financial crisis. It has indeed saved a lot of money; however, it has also cost a lot of people quite a bit of money. The question is, is an interest rate of 0.5% really a good idea?

Good Idea

The people who have really benefitted from the low interest rate are the 11.2 million British mortgage holders. This is actually who the policy was primarily designed for in the first place. The idea being that lower interest rates would bring down mortgage payments and take a huge burden off many Britons. The interest rate on mortgages has dropped quite dramatically. For instance, what may have been a 6.4% interest payment on a 25% deposit between two to five years is now between 2.4% and 3.3%. This means that people are actually able to borrow at less than the rate of inflation. This policy has surely saved many thousands of people from dropping into arrears, by saving roughly £100bn in mortgage payments over the past five years according to Bob Pannell, chief economist at the Council of Mortgage Lenders (CML).

Bad Idea

As with any policy there are always going to be people who oppose it, primarily those who it has had a negative effect upon. An interest rate of 0.5% for five years has harmed small businesses, first time home buyers, savers and pensioners. The irony of course is that many of these people are also mortgage holders, so they get the good and the bad. Savers have no incentive to save money anymore. With such low interest rates, the amount of interest that they are receiving is tiny with most savings accounts providing below 1% interest. Even the popular tax-free individual savings accounts (ISAS) have suffered with few if any paying above or equal to 2.38%, the rate of inflation. This presents a problem as with less people saving there is also less credit within the country. Management consultants McKinsey estimate that between 2007 and 2012 UK savers have lost £66bn. So although the credit is cheap, there is less of it available for small businesses.

At the same time, the advent of cheap credit has also lead to the rise of so called zombie companies. Such companies only survive due to cheap credit, but they have no hope for future growth and are not being allowed to die and make way for other companies. An estimated 10% of British businesses are now a zombie firm never able to pay off its debts or expand.

Despite the positive effect it has had on mortgage repayments there is a negative twist in housing.  It is for the young first time buyers. Due to the unattractiveness of saving, and the cheapness of mortgages, the obvious place to invest is in property. This, however, increases the cost of housing and rent a huge amount. This at a time when wages are low and stagnant means most first time buyers are out of the market. It doesn’t matter how low the cost of borrowing is, if every house except one on a remote Scottish island is out of your budget. The old have also suffered with pension funds being badly affected by low interest rates. Many pension funds are finding it hard to have enough investments to hold the funds together.

So although the low interest rate has certainly had its good points stopping many people from falling into arrears. It also has had a negative effect on many people and businesses. Whether or not it is a good idea is not a simple question and it depends on who you are. It should also be noted that if the country is to return to a fully functioning economy then the interest rates will need to rise. True economic growth can only happen when the money is being generated within your own country. That kind of growth would certainly require an increase in interest rates. Perhaps the best solution is to start a gradual increase in the rate of interest.