Running an Excessively High Saver Interest Rate May Suck Liquidity Out of the Broader Economy

Abstract

In the broader economy, there are two key interest rates that impact significantly on the functioning of the economic system alone and in combination: (i) saver interest rate, and (ii) home loan interest rate. This abstract idea preprint focuses on the impact of a mis-tuned or mis-aligned saver interest rate on the broader economy. Saver interest rate here refers to the fixed deposit interest rate. Consider that a country faces a credit crunch where there is a shortfall of cash in the broader economy to finance new loans for new small and medium sized business. In addition, there may also be a need to hold cash in local banks to prevent a collapse of the exchange rate of the local currency. Under these circumstances, there may be a temptation for politicians to increase the saver interest rate to attract funds to local banks. While this may work to temporarily ameliorate the funding shortfall, an excessively high saver interest rate may remove too much cash or liquidity from the economy. Such a situation may cause a mild depression in the broader economy where there is less consumer spending, which in many advanced economies, is increasingly an important component of gross domestic product. Hence, there is a need for careful consideration in setting the saver interest rate to prevent removal of too much liquidity from the broader economy in too short a time.

Keywords: saver interest rate, broader economy, fixed deposit, liquidity, housing loan interest rate, micro-economics, macro-economics