Low interest rates are good for economy?

Question

So the way I understand it:

1- Low interest rates lead to lower savings and higher expenditure
2- Higher expenditure results in more economic activity
3- More economic activity results in more jobs
4- More jobs create more wealth
5- More wealth allows for higher expenditure

If that is the case, wouldn't an economy be best off when the interest rates drop to zero? Why not?

But with all the excess wealth, wouldn't people want to invest, hence replacing debt capital with equity capital?

In fact, if you add a tax on savings (disincentive to save) would you not ensure that wealth keeps circulating a maximum number of times, rather than sitting idle in banks?

Would that not be a solution of lack of funds???

Answer 1

No, you're wrong. Low interest rates are NOT good because they discourage savings. They are good because they encourage people and businesses to take out loans. This boosts GDP because people use loans for consumption purchase (one component of GDP) and business take out loans for business investment (another component of GDP). So yes it results in more economic activity -- but not at the expense of no savings.

In fact savings and investment are necessary to fund the loans. Bank loans come from bank savings. And business can only sell bonds when people are willing to invest in bonds.

But anything taken to excess can be bad. The primary reason you don't want interest rates to be TOO low is that all that aforementioned lending would ignite inflation -- bank loans increase the money supply, and if the growth of the money supply outpaces the economy's productive capacity, the result is inflation. Too much money chasing too few goods. And high inflation is undesirable.

This is the entire reason that the Federal Reserve attempts to influence interest rates and is often raising the rates it controls.

Answer 2

yes you would not be able to get a loan with zero interest also raising interest rates from time to time is a tool for the federal reserve to keep inflation under control.

No there wouldn't be any excess wealth because if you had no interest rate all banks would go out of business, people would not find money to borrow and start new businesses or buy homes and inflation would go so high that the dollar would become worthless.

Answer 3

No, without interest there would be no incentive for anyone to offer loans. Most people need loans to make major purchases; few cars and fewer houses would be sold.