Current Interest Rate Trends: "Germany Can Do Without Interest Subsidies"

One man's meat is often another man's poison. An example of this somewhat old-fashioned maxim can be found in today's interest rates. While high-debt nations and homebuilders celebrate the historically low rates, those who want to invest - whether in the form of small-time saving accounts or billion-euro pension funds - are suffering. Investors in German bonds now earn around 0.4 percent interest, with real interest rates probably in the negative. Anyone seeking higher rates of return must be prepared to take big risks. For years, politicians and economists preached the importance of personal savings to offset depleted state pension funds due to shifting demographics. Now it appears that personal savings are falling short because interest income is too low.

In view of these developments there have been growing calls to halt falling interest rates. Georg Fahrenschon, the president of the German Savings Banks Finance Group, suggested using tax-funded subsidies to raise rates. Is this a good idea?

It is right to warn of pension gaps potentially affecting many. But it isn't the government's job to make people's decisions for them; it should only ensure that people don't rely on the state for what they fail to put aside for retirement. This means requiring that everyone pay a certain amount into private pension insurance. If the mandatory state pension (based on a pay-as-you-go model) isn't enough, it makes sense to supplement it with payments into private insurance schemes. Policies that force people to save are unpopular. What’s more feasible is a system that automatically withholds a portion of earnings and puts it toward retirement, but allows those affected to opt out if they choose. Behavioural economists call this "nudging" - gently pushing people in the right direction.

Adding new tax financed incentives to foster private savings is not the way to do it, however. Such subsidies would mostly benefit higher income households, which tend to save anyway and have assets. What is more, they strain the public purse and can end up subsidizing the financial sector, where the savings support is consumed by high fees. Policies that foster private saving should be restricted to old-age provisions for households with low incomes, and they should be combined with mandatory retirement insurance.

Interest rate subsidies beyond that can create undesirable effects. Changes to interest rates do not only have a redistributive effect on creditors and debtors. They also affect economic behaviour. Currently those saddled with high levels of debt in Europe - states, companies, households - are trying to pay off what they owe. Low interest rates signal that demand for capital is low, and, at least in the short term, that fewer savings are needed. It is important that those with savings feel this, so they put their money into investments that make sense for the overall economic development, such as housing, continuing education, or increased consumption. This clear signal to the market should not be interrupted by fiscal intervention.

This article was first published in the Frankfurter Allgemeine Zeitung on 6th March 2015 on page 25.