Are Low Interest Rates Better for Savers or Borrowers?

In the current low interest rate environment, it’s common to wonder who benefits: savers or borrowers. Savers dutifully put pennies in their piggy banks, giving up some current consumption for future spending power. Borrowers make purchases now with a promise to repay the money in the future – buy now, pay later. 

“In a low nominal interest rate environment, the rate of return on savings accounts is going to be lower, as is the cost of car loans or mortgage loans, what have you,” said David Wheelock, vice president and deputy director of research at the St. Louis Fed. 

So, the obvious answer sounds like borrowers. But answers related to monetary policy are rarely that simple.

Thinkstock/Kittisak Taramas

A Quick Refresher 

Before we get started, let’s define some of the terms we’ll be covering.

• Inflation: A general, sustained upward movement of prices for goods and services in an economy. 
• Nominal interest rate: An interest rate before taking inflation into account. For example, the interest rate you often see listed for a savings account is a nominal interest rate. 
• Real interest rate: The rate that investors, savers or lenders can expect to receive after allowing for inflation. To calculate your real interest rate, simply subtract the inflation rate from the nominal interest rate: 

Real interest rate = Nominal interest rate – Inflation rate 

The Inflation Factor

Let’s go back in time to the 1970s. When disco music was the rage, the U.S. had relatively high nominal interest rates. Savings accounts boasted returns of 5 to 10 percent. But inflation was as high as 7 to 13 percent.

“So, they’re actually losing money in terms of purchasing power,” Wheelock explained, since savings accounts were accruing a lower amount of interest than the rate of inflation. 

In more recent times, inflation has been closer to 2 percent. Interest on most savings accounts remains comparatively low. At the time of this writing, some certificates of deposit are offering 2.5 percent or higher annual percentage yields. If the interest that a CD earns can beat inflation for the term that you hold it, “you’re actually making money” in real terms, Wheelock said.  

“You have to consider inflation as well as the nominal interest rate when deciding whether you’re well off as a saver or borrower in a particular environment,” he said.

What Can Benefit Both Savers and Borrowers?

One measure of a healthy economy is growth in gross domestic product, or the value of all the goods and services produced in the economy. Another is full employment. And that brings inflation into the equation: By keeping inflation low and stable, monetary policy gives the economy its best chance to grow. 

“Ultimately, what benefits both borrowers and savers is a healthy, growing economy with low and stable inflation,” Wheelock said. 

Additional Resources

• Economic Lowdown: Getting Real about Interest Rates
• Economic Lowdown: Inflation
• Open Vault: How Does the Federal Funds Rate Affect Consumers?
• Soar to Savings Online Course for Consumers