What is in this article?:
- You decide: Are interest rates headed higher?
- Alternative places to put money
• This is why most Fed-watchers are convinced the bank will eventually increase interest rates; so it’s not an “if” but a “when.”
• Already, longer-term interest rates, which the Fed does not directly control, have been edging higher.
In the years right before his death, my father became very interested in investments. Maybe it was because he wanted his financial affairs in good order before he passed. Or maybe he became caught up in all the discussions about investing during the Great Recession. But for whatever reason, he continually peppered me with questions about where he should put his money and what was going to happen to different kinds of investments.
Especially late in his life, my dad primarily put his money in insured CDs (certificates of deposit). He didn’t have to worry about possible losses, and if he kept the term of the CDs short, he could have reasonably ready access to the money for unexpected medical or other costs.
But the big downside of my dad’s investment strategy was the interest rate he earned. He continually complained to me about how low it was. And he was correct. For several years, interest rates on insured CDs and similar financial investments have been at historic lows.
Why? There are two big reasons. First, inflation has been low, hovering between 1 percent and 2 percent annually for several years. Any interest rate paid on an investment will reflect prospects for future inflation. The higher the expectations for inflation, the higher the interest rate. This is because inflation erodes the purchasing power of dollars. So if inflation is low — and expected to continue that way — then interest rates will be low.
The second reason results from the policies of the nation’s central bank, the Federal Reserve. The Federal Reserve (the Fed) has a lot of power over the level of short-term interest rates, just like those rates earned by my late father on his CDs. And for the last five years, the Fed has purposefully kept those rates super-low.
Did the Fed set low interest rates to hurt savers like my dad? Of course not. Instead, the Fed has been following an 80-year-old policy.
The Fed’s playbook is to keep interest rates low during recessions to encourage two changes in the economy. First, while low interest rates may discourage savers, they do make borrowing cheaper. One of the traditional ways the Fed has tried to push the economy out of a recession is to stimulate borrowing, which in turn leads to more spending and increased jobs.