Home

Explaining Interest Rates with Hamburgers

Popeye the Sailor Man has a sidekick named Wimpy, with a prodigious appetite, who famously says "I'll gladly pay you Tuesday for a hamburger today." Wimpy provides a classic example of consuming now and paying later. The Federal Reserve, by continuing to keep interest rates low, is promoting such behavior.

Think of low interest rates as making money cheap. With cheap money, there is an incentive to borrow and consume now and repay the debt in the future.

In fact, that is what the Federal Reserve has sought to accomplish. In response to the recession that began in 2008, the Fed moved to dramatically reduce interest rates in an effort to spur spending and revive the economy.

 While borrowers, such as anyone with a mortgage, benefit from lower rates, there are losers as well. Savers have been suffering, especially retirees. If you want to be cautious with your money, you are earning a meager return on CDs and bonds. This forces people to take on more investment risk than desired in order to obtain a reasonable return on their assets.

The effectiveness of the Fed's actions have been hotly debated. Even if it has worked in the past, low interest rates may have limited positive impact going forward. The stock market has recovered nicely, for example; but it might be too dependent on low rates.

In the end, we need to be cautious about how the low rate environment can lead resources to be misallocated, both by individuals and businesses. Cheap money can cause Wimpy to eat more hamburgers today than is prudent.