Naked Capitalism has the story Nobel Prize Winner Robert Merton Slams Fed for “Negative Wealth Effect” Policies. This post is a discussion of the Pensions & Investments article Monetary policy: It’s all relative by Robert C. Merton and Arun Muralidhar.
The Naked Capitalism article starts with the explanation:
Nobel Prize winner* Robert Merton and Arun Muralidhar have charged ZIRP and QE happy central banks with economic malpractice. One of the main justifications for low interest rates is that they create a “wealth effect” by elevating asset prices. People allegedly feel richer and spend more, stimulating growth.
As we’ve pointed out, the first central bank to try the bright idea of lowering interest rates to spur consumption was Japan in the late 1980s. We know how that movie ended. Japanese banks and companies engaged in what was then called zaitech, or speculation, funded by being able to borrow 100% against urban land.** The result was to massively inflate already-large commercial and residential real estate bubbles, and to funnel Japanese cash into largely misguided and/or overpriced foreign investments.
Super low interest rates lower incomes to asset owners, producing what they describe as a “negative wealth effect”. The Fed seems to think that retirees and others who live mainly off their assets will happily eat their seed corn, um, liquidate some of their capital gains to make up for the loss of income. Instead, people in that position who come up short most often curb spending.
As a retiree who is managing my own investments just as Merton and Muralidhar describe, I can attest to the fact that I am behaving just as they say I should. Though I have had a good boost in my net worth, my income has not gone up by much since the crash of 2007-2009. Perhaps Merton and Muralidhar are not devotees of the newsletter Investment Quality Trends. IQT’s methods do extract a little rising income out of the current situation. without eating into your principle. As I mentioned above, both my principle and income have increased since the crash, although the income is way down from the pre-crash level and my net worth is above the pre-crash level. I have adjusted my spending in response to my new level of income.
I have since realized that no matter what my dividend income is, I should limit my expenditures to no more than 5% (maybe it is 4%) of my invested assets. According to historical performance, that level of spending should be sustainable pretty much forever. I have modified my investing goal from what used to be just maximizing my investment income stream, to a mix of capital appreciation and investment income, where the income doesn’t have to be more than about 5%. The rest can be capital gains. If I manage income higher than 5%, I just reinvest the excess instead of happily spending it.