Falling Interest Rates: Not Everyone's A Winner

Australia's official interest rate was reduced by 1 percent today: "RBA slashes rates to 3.25pc". Good news for some I'm sure, but for people relying on investment income to pay their bills, it's another shock to deal with. Not only have they seen the value of their investments (e.g. shares and property) fall thanks to the global financial crisis, but in the past few months they've seen returns on their bank deposits plummet.

What irks me is that parts of the media focus only on the "good news" side of the story, and neglect to mention the consequences on self-funded retirees and other people who rely on interest from their money. Remember, people who save money (rather than borrow and spend it) provide the capital needed to finance economic growth.

And the suggestion by some finance experts/talking heads that the Reserve Bank should go even further, citing the near-zero rates in the United States, must surely be joking. They do know what a Liquidity Trap is? The US looks like it's going to suffer a similar fate to that which stalled the Japanese economy in the early 1990s. Investment evaporated, economic activity actually fell even further (i.e. the recession deepened) and deflation set in.

Let's hope governments around the world learn from the lessons of the past. Cutting interest rates to zero won't be enough to get us out of this jam.

[Adelaide's maximum temperature was only 36.3 degrees Celsius (97 degrees Fahrenheit) today. Unfortunately the temperature looks likely to rise before we get a real change.]

Update: About that deflation risk (by Paul Krugman).