Low interest rate - the underlying cause

Why is interest rate so low? The simple answer is there is a big supply of money and insufficient demand for money. What cause this imbalance?

The low demand for money is caused by low consumption. The low consumption is caused by low wages and high unemployment, which has affected a large part of the population, and brought out a large disparity in income distribution in recent decades. The lower and middle class people have to work harder to earn enough to survive. They have fewer children, which also contributed to the drop in demand over the years.

The supply of money has also been increased by governments through their monetary policy and recently, through stimulus spending. With so much money in the economy and little demand, interest rate is likely to remain low for a long time.

This is bad news to retirees who have to depend on their investment income to live on. With low income from their savings, they have to spend their capital sum, which will deplete over the years.

What can retirees do? They have to invest in equities to earn a higher return. Although equities have a higher level of risk, it can be mitigated by investing in a low cost fund, such as an exchange traded fund. The return on equities is likely to be around 5% to 7%, which is much better than 2% on government bonds.

In the past two decades, there was demand for money but they were used to create asset bubbles, especially in housing. This helped to boost the world economy for some time. The recent collapse of the asset bubbles brought about the economic downturn. However, the asset bubble is being revived, but this is not a long term solution.

In my view, the solution is to generate demand by giving people a chance to work and enjoy fair wages, so that they can feel secure about their future, raise a family and spend time on leisure. With a sound economy, there will be a demand for money which will give a fair return on their savings.

Tan Kin Lian