Low interest rates have meaning to consumers, savers, investors, businesses, governments, and the wider economy, affecting them in positive and negative ways.
For consumers, low interest rates open the door to opportunities to acquire consumables like clothing, consumer durables like furniture and appliances, and assets such as motor vehicles and housing – what many Jamaicans consider the dream asset. Housing becomes more affordable because borrowed funds for construction cost less and mortgage rates fall, making it easier to fulfil life goals.
But there is a catch: easier access to loans can lead to careless spending, overpowering debt, and low credit scores, which have the potential to reverse previous gains.
Low interest rates should be seen through the doors they open to secure assets with good long-term potential. Education is a good example. Housing is another. Consumers can also seize the opportunity to move from consumer to producer by borrowing to start businesses.
Although it is wise to save a portion of income rather than consume all, low interest rates do not create an incentive to save. Yet people must save to make the future better. The savings strategy should revolve around getting the best safe rates such as those on short-term government and corporate financial instruments and fixed deposits in preference to savings accounts, which hardly pay anything meaningful.
Investment
Investment is a mixed bag. New fixed-rate debt instruments with a lower coupon yield lower returns. The interest on short-, medium-, and long-term instruments issued prior to the lowering of interest rates is not affected. What is affected is the price of medium and long-term instruments, which moves in the opposite direction to interest rates. So if rates fall, the price of such instruments increases, but this yields nothing if they are not sold.
When interest rates get lower, it is less favourable to invest in variable-rate debt instruments than in fixed-rate instruments as their return falls. That their return is higher than that of the instruments to which they are pegged gives them an advantage, though.
For investors with the capacity and willingness to take higher risk, low interest rates can be a blessing if they give a boost to the stock market. But as we have seen in Jamaica, lowering interest rates does not necessarily cause stock prices to jump – at least not immediately.
It is reasonable to expect stock prices to increase given that the cost of new debt incurred by businesses should be lower than that of older fixed-rate debt. To the extent that the cost of debt falls and other expenses are kept in check, and especially if sales increase, profits should rise and make stocks more attractive.
How interest rates affect the price and income from securities should be of interest to people who invest in collective investment schemes – unit trusts and mutual funds. Lower interest rates mean less interest income, but higher asset prices boost fund values. Money market funds and bond funds yield less, but equity funds and blended funds benefit when low interest rates eventually contribute to the rise of the stock market.
Pension fund members are affected in a similar way to investors in collective schemes because of the strong or weak growth the value of their invested contributions may experience. The same is true of policyholders whose life insurance policies are linked to segregated funds, the performance of which ultimately determines living and death benefits.
Businesses and Government
Businesses also love low interest rates. Cheaper money facilitates the acquisition of fixed assets, repairs, and maintenance, retooling of the physical plant, and even raising working capital. Lower costs reduce the level at which a business begins to make a profit, and more profitable listed companies become more attractive to investors.
Governments typically love low interest rates, more so if their countries have variable-rate debt or incur new debt. Lower debt servicing charges allow more funds to be directed to other priorities.
But governments may not like this: low interest rates can cause savers and investors to move money abroad to take advantage of higher rates, thereby putting pressure on the national currency.
Low interest rates are a tool central banks use to stimulate the economy, which is why Bank of Jamaica governor Richard Byles wants banks to lower lending rates. They make borrowing cheaper, encourage spending and investment, boost demand, cause the economy and employment to grow, and create opportunities for higher returns on moderate- and high-risk portfolios. But they can also cause borrowers to take on too much risk, and hurt pensioners, savers, and conservative investors, who earn less on deposits and safe assets.
Oran A Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com
