Can Fed come up with a better system for encouraging long-term savings?
Question/Comment: I inherited some money, retired, and moved to Portland, Ore. Now that I have money in the bank, and the Fed has been lowering interest rates, I’ve been wondering exactly how our banking system actually works.
When the Fed lowers the interest rate for money loaned to banks, I’m assuming that the new rate only applies to new loans, and not to money previously loaned, which I’m assuming the bank would still have to pay back at the original, higher rate.
Now, when I deposited a chunk of my money in an interest-earning bank account a couple of years ago, when interest rates were higher, wasn’t I essentially “loaning” money to the bank? So, how is it that the bank can justify lowering the interest rate it pays me for money that it continues to keep in its possession? Right now, it feels like, “Heads I lose, tails you win.”
Obviously, the Fed’s interest rate, as a matter of practice and tradition, is tied to the financial system as a whole. But why can’t the system be changed so people with bank accounts aren’t punished when other segments of the economy need a boost? If investment firms can come up with all sorts of new and creative investment tools to encourage investment, why can’t banks and the Fed come up with a better system, besides just CDs and ordinary bank accounts, to encourage long-term savings?
Paul Solman: The key realization, Peter, is that the bank is
simply the “intermediary” for your money. It’s taking in it and
“putting it to work” — lending it out again. It makes a spread on the
difference between what it pays you and what it gets from borrowers,
minus the defaults it suffers. If the interest it gets on the open
market goes down because the Fed lowers rates, it pays you less.
Otherwise, there’ll be no spread and it won’t make any money. Remember,
banks are profit-making institutions, or at least they’re supposed to