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This paper explores the effects of a long-term low interest environment as it pertains to general economic growth, the stock and bond market, the wealth gap, and retirees. The Federal Reserve (Fed) will often lower interest rates during periods of economic slowdown (like a recession) to stimulate economic growth. Low interest rates make it cheaper to borrow money to finance investments, but low interest rates do have a dark side.

As we will show in this paper, although low interest rate policy is not correlated with GDP growth and spurs increased stock valuations, long-term low interest rates hurt profitability in the bond market, harming those who lack the wealth to handle the high-risk nature of the stock market. Even more so, this environment’s presence during the pandemic moves Social Security trust fund depletion up and hurts savings for retirees. The dark side of low interest rates then worsens the already-large wealth gap and the already-difficult aspect of retiring.


On March 11th, 2020, the World Health Organization (WHO) declared the novel coronavirus a global pandemic. Two days later, the United States declared a national state of emergency, sending the financial markets in a downward spiral. Following the pandemonium, the United States Federal Open Market Committee (FOMC) committed to keeping the Federal Funds Rate at or near zero until the economy makes a full recovery: 2% inflation and full employment. Since then, consumers, investors, and producers began to speculate the effects a low interest rate may have on aspects of economic activity relevant to them.

This piece aims to bring clarity to that speculation by addressing the effect of a long-term low interest rate environment on a few crucial parts of the economy. While low interest rates are not a new phenomenon, they are certainly rare in the long-term, and research in this area is limited. Low rates have differing effects on the many groups in the economy, but one thing is certain: everyone is impacted in some way. In this paper, we will explore the impact of this environment on general economic growth, the financial markets, income inequality and the retirement system.

Nobel Prize Winning Economist & Stanford Professor Paul Romer on Hyperinflation & Protecing Science

In general, our paper shows that a low interest rate has less economic stimulus than a high interest rate does. The ideal interest rate should maintain at 9%. However, this result contradicts the historical data, as we can see that during the most time in history, FOMC has kept the interest rate lower than 5% since 2000. This is, of course, the theoretical result, the Fed will take many other aspects into account. For example, the financial market. 

We find explicitly positive correlations between rate-cut & stock market evaluation, where rate-cut boosts major indices (e.g. S&P 500) after a short-term of price decline due to market fear. We also find that mid-cap ETF performs the best among selected types of ETFs. Moreover, we develop a bubble identifier due to the concern on the relationship between the fast-rise-up asset evaluations and the stock market bubbles.

Education – Rebellion Research

Building on the use of ETFs, we find that U.S. bond market ETFs are performing as expected, with a yield decrease leading to a price increase in the market for currently maturing treasury, municipal and corporate bonds. This prolonged low interest rate environment encourages investments away from the fixed income market and towards the riskier stock market.

We posit that the Federal Reserve’s continued spending to keep the U.S. economy afloat has unintentionally increased income inequality by indirectly bolstering the stock market. There is a history of high income populations owning a disproportionate amount of the stock market compared to low income populations. With all major stock indexes performing well since the mid-March-COVID-19 crash, the rich have received far more in returns than the poor. Further, in an environment where lower income populations are taking a harder economic hit, the wealth gap should only increase during COVID-19.

Given the importance of a steady income stream leading into retirement, we explore the impact of low interest rates and the current economic situation on various sources of income in retirement and on the Social Security funds. As we will discuss in this paper, the lowered returns in “safe” investments, like bonds, and drop in payroll taxes may play into a quickened depletion of funds.

  1. The Threshold Effect of Interest Rate on Economic Growth

In crisis mode, the FOMC plans to maintain the Federal Funds Rate between 0% and 0.25% to re-achieve full economic function as effectively as possible. The Fed hopes that this can spur investment growth in the near-term. Lowering interest rates is a common short-term strategy when the economy faces a downturn, and it has helped bolster investment spending in the past. While the low interest rate policy is effective for increasing activity in the financial markets, the policy falls short when it comes to growth in U.S. Growth Domestic Product (GDP), which, in an advance estimate, decreased at “an annual rate of 32.9%” in Q2 2020.

In this section, we seek to find out the interest rate that promotes the highest GDP growth for a regularly functioning economy. To do this, we will explore whether growth and/or investment are feasible for all possible levels of interest rate, and if there is a threshold level of interest rate above which growth or investment turns negative. The purpose of discovering the range is to find out where the Fed can set interest rates and still see economic growth.

Based on modern economic theorem, the Fed uses interest rates as a lever to help achieve their objectives of promoting maximum employment and maintaining price stability for goods and services. If the economy is slowing, the Fed can lower interest rates to make it easier for businesses to access loans, conduct investments, and create jobs. Lower interest rates also tend to make consumers more eager to borrow and spend, which helps spur the economy. If the economy is growing too fast, the Fed may raise interest rates to curb inflation. 

The last time the FOMC cut the Federal Funds Rate (FFR) to 0.25% was in December 2008 to save the worst financial crisis since the Great Depression. The rate stayed low until 2015. Then, as the economy recovered, the Fed began to raise the benchmark steadily until 2018. Thus, it is crucial to ask whether the interest rate level is appropriate, and when it can be harmful to economic growth. 

As John B. Taylor pointed out in his Taylor Rule, there exists a linear relationship between interest rate and GDP. Thus, we have outlined an initial equation to find the optimal threshold interest rate below:

ln(GDP) = β0 + β1*(r)+ β2*D*(r – r*) + ε 

where GDP is the dependent variable (i.e. ln(GDP) is the growth rate of GDP or growth rate of investment),  β is the coefficient of different terms, ε is the error term which reflects effects left out by our independent variables here. For independent variables, r is the interest rate and r* is the interest rate threshold; thus, the term, D*(r – r*), is an indicator function. 

To determine how the FOMC’s current low interest rate policy affects economic growth, finding the optimal threshold interest rate may provide some insight. To do this, a regression model is employed to discover the linear relationship between the dependent variable — in this case the natural log of GDP — and independent variables. Our analysis seeks to find the optimal interest rate in the range of 0% – 15%. After running the regression, seen in Figure 2, the optimal threshold interest rate is at 3%, where the lowest residuals sum squared (RSS) is found. 

 Figure 2

Upon secondary consideration, however, we assert that the variable ε can contain too many other effects which will also influence GDP that are uncorrelated with the interest rate. This is evident in Figure 2 because of its large RSS numbers. One such independent effect that could influence GDP is inflation(CPI). To resolve this problem, we add CPI as its own independent variable.

After that revision, the equation evolves to

ln(GDP) = β0 + β1*(r) + β2*D*(r – r*) + β3*(CPI) + ε

 Figure 3

The lowest RSS appears at 9% as shown in Figure 3. 

When CPI is added as an influential independent variable, RSS decreases significantly, giving us a more accurate idea of what our model finds as the optimal threshold interest rate. What is surprising is that the threshold interest rate jumps to 9%, a rate far greater than any previously set by the Fed.

​Adding variables may generate a problem called “multicollinearity”, which conveys the correlations between the independent variables. If this problem exists, it violates the assumption of the regression model. To resolve this issue, we test the multicollinearity with a VIF test as shown:

According to the multicollinearity check in the results below, the variance inflation factor (VIF) of all three variables is less than 104.That means these variables are less likely to be a linear combination of the other two variables and we can get rid of the modeling issue. o

 Figure 4

To be sure of the findings, we want to test whether an explicit relationship exists between interest rate and economic growth. To do this, we test for endogeneity and exogeneity; if the result shows endogeneity, there is a problem of unclear causality. If it shows exogeneity, there is no problem. Based on the previous literature, Stéphane(2003) suggests we can use lagged variables as an instrumental variable to test our model’s endogeneity and exogeneity, which in this case is the lagged interest rate. As shown in Figure 5, the two tests’ result has a p-value over 20%, which means we fail to reject the null hypothesis (H0) that there is causality between interest rate and GDP growth. The interest rate in our model is exogenous and there is no endogeneity problem, and therefore the findings from the figures above have accurate causality.

From here, it is clear that there is a threshold (9%) for the interest rate, which will give the highest GDP growth rate. However, the FED hasn’t given such a high interest rate since 1989. Government bodies need to consider other variables including those we will discuss in this paper when setting the interest rate. 

    Figure 5


(PDF) How much is too much: The threshold effects of interest rate on growth and investment in Nigeria

Current Federal Reserve Interest Rates and Why They Change

2. How Zero Interest Rates Affect Stock Evaluation

2.1 Data Source

All data used in this section is collected either via an API using pandas datareader from python, or from websites including the Wind Terminal,, and FRED.

2.2  Index Performance

In an effort to stimulate the economy during the pandemic, the Fed cut interest rates below historical averages. Doing so gives companies lower costs of borrowing to expand their business by acquiring new PPE, hiring staff and investing in R&D, among other actions. As we will demonstrate in this section, stocks’ prices should rise from a rate-cut in most cases. Data for S&P 500 (^GSPC), Dow Jones Industrial Average (^DJI), Nasdaq Composite (^IXIC), Nikkei 225 (^N225), and STOXX 50 (^STOXX50E) are collected from a customized API function in Python. Codes for the API function is listed in the appendix. A notice is that data for FTSE 100 is collected through due to the lack of historical data through the API source.

Figures 6-9 

The graphs above show how the three major U.S. stock indices have performed over the past thirty years and how Japanese, European Union, and United Kingdom stock indices perform during their corresponding zero interest rate (ZIR) period. In Figure 6, the Fed rate-cut dates are marked with a yellow line. The indices generally rise after a rate cut period. During well-known recession years such as 2001, 2008, and 2015, all indices show upward trends and decline simultaneously. We observe a close correlation within these indices as demonstrated in the Figures 10-13:

 Figures 10-13

Because there are significant positive correlations between the U.S. and the other three major markets within the ZIR period, we will focus on analyzing how the zero and low-interest rates affect the U.S. stock market.

2.3 Sector & ETFs performance

In 2008, the Fed cut the target federal funds rate to between 0 and 0.25% for the first time due to the ongoing Financial Crisis. The rate did not increase until December 2015. For a more detailed look on how the low-interest-rate period affects the US stock market, we will calculate the sector-wide compounded annual growth return (CAGR) & volatility based on the S&P 500 sector classification, and compare how the Vanguard Dividend Appreciation ETF, Value ETF, and Large-Cap & Mid-Cap & Small-Cap ETFs perform. As stated above, the data is collected via Python API pandas datareader.

Figures 14-15

The sea-green bars represent the sector’s CAGR, and the red lines represent volatility (note, however, that the length of the red line does not represent the real value of volatility, only a comparison among those volatilities). Consumer Discretionary (COND), Information Technology (INT), and Healthcare (HLT) were the three most profitable sectors. While the Energy (ENG) sector had the worst return, it has relatively large volatility, indicating that the sector experienced a recovery-peak-to-decline during the ZIR period. The Finance (FIN) sector did not perform as well as the other sensitive sectors. While the reasoning for its poor performance is unclear, it may be due to the banks’ loss in money on mortgage defaults or interbank lending set to freeze.

Mid-Cap ETFs had the best performance with Small and Large-Cap following closely behind. This supports Fame-French’s theory that company size matters as Small and Mid-Caps tend to perform better than Large-Caps. The Dividend ETF (DIV) and Value ETF (VAL) are less volatile than the company size ETFs.  

2.4.1 Inflation rate and interest rate

As previously stated, economists generally believe that the inflation rate should be around 2% in a healthy economy. Based on conventional central banking wisdom, if the Fed wanted to increase the inflation rate it should decrease the Federal Funds Rate (FFR), which is generally referred to as the nominal interest rate. In the 2008 recession, the inflation rate crashed and then rose after the interest rate dropped to near zero. However, as pictured in Figure 16, inflation began to decrease again shortly after when the FFR was still low. The graph also shows that the two rates are both moving similarly towards 0%. Figure 17, a scatter graph of two series of data beginning from 1971, demonstrates that there may be a positive relationship between inflation rate and nominal interest rate. Furthermore, the Pearson correlation coefficient is 0.75, implying a significant, positive linear correlation trend.  

Source: Board of Governors of the Federal Reserve System (US), “FEDFUNDS;” U.S. Inflation Calculator.

Figure 16-17:

In March 2020, the inflation rate was 1.5% and then decreased to 0.1% in May. Due to the low-interest-rate policy, which brought the interest rate to its lowest point in April, the inflation rate rebounded to 0.6% in June. This trend of rebounding should continue in the short term. However, as mentioned above, the low-interest rate will lead to a low inflation rate in the long-term. Like the Neo-Fisher theory states, if a central bank wants to increase the inflation rate, it should increase its nominal interest rate target.

2.4.2 P/E ratio and inflation rate

While the Sector Performance data does not suggest any explicit connections between sector P/E and low rates, the inflation rate seems to have some correlation with the P/E ratio. To explore the inflation rate’s relationship with both the interest rate and P/E ratio, we used the inflation rate as the intermediary before relating the variables. 

From the historical data, we see that the S&P 500 P/E ratio and inflation rate tend to move in opposite directions. This trend was most evident during the 2008 financial crisis, when the Pearson correlation coefficient of these two series of data was -0.49. Generally, low interest rates lead to low discount rates, then the Net Present Value(NPV) will be higher, which stands for the current value of future cash flow.

Thus, with the same cash flow and period of time, the current prices of  investments or stocks will increase, leading to a higher P/E ratio. On the other hand, if the inflation rate is high, the denominator (‘E’ – Earnings Per Share) will increase more quickly than the numerator (Price), leading instead to a lower P/E ratio. Based on this trend, the current low-interest rate leads to a lower inflation rate in the short-term, and a low inflation rate may lead to higher P/E ratios.

Figure18: S&P 500 P/E via Multpl

2.5 Further Concerns about the Bubble

As we have shown, rate cuts generally lead to a rise in stock valuation. Because of this, the low-interest rate could also lead to an asset-pricing bubble as it did in the housing bubble in the mid-2000s. Moreover, with the Fed’s announcement that it will keep the interest rate near zero to stimulate the economy until there is a full economic recovery, we should carefully observe whether there exists a bubble in the current stock market. If the bubble is not found in high P/E ratios, we may try to find bubbles by the customized “price difference quantile threshold method” as outlined below.

Price Difference Quantile Threshold

For each data point, the method calculates the customized bubble-identification-ratio (b-i-ratio), which is equal to the price difference over the past one year divided by the standard deviation of the prices over the past year. The bubble identification  threshold is trained by calculating the average b-i-ratios of the dot com bubble period and the housing bubble period, which is roughly equal to 1.19. We also set the severe bubble identification threshold to be equal to 1.5. By applying the method through the whole dataset, each point identifying a bubble is labeled with a salmon line, and each point identifying a severe bubble is labeled with a red line. The result is shown in Figures 19-24.

Figures 19-24

We observe the red lines beginning around 2015 and some consecutive salmon lines around 2019. The concentration of these lines suggests that there is likely a bubble in the current U.S. stock market and that the bubble may burst soon. However, we cannot guarantee whether or not the bubble completely bursted in March due to the market fear of the COVID-19 pandemic because ZIRP will exist in the following years, as will uncertainty.

Unprecedented volatility in the stock market and low inflation could lead to inflated P/E ratios which, when combined with the Federal Reserve’s commitment to low interest rate policy, could put the stock market in an asset-pricing bubble situation. This is an undesired but possible consequence of the Fed’s policy. Stock pricing has climbed rapidly since mid-March, and we will continue to track their potential to create a bubble that could once again throw the markets into disarray.

The Bond Market

Unlike the highly speculative and promiseless nature of the stock market, the U.S. bond market has generally provided a safer alternative to allocate money in the face of uncertainty. When the FOMC committed long-term to their low-interest rate policy in mid-March, the bond market saw an immediate decrease in yield and increase in price.

While already maturing fixed income instruments saw a relative appreciation in value, the yields of the bond market going forward decreased dramatically. The yields have mostly stayed there since, and as long as the FOMC continues its commitment to keeping the Federal Funds Rate (FFR) between 0% and 0.25% as it has thus far, the current and futures bond market will continue to operate at very low yield levels.

We are able to see the inverse relationship between price and yield in the bond market by looking at the current decreasing yield levels and the increasing price of all U.S. fixed income sector ETFs from the time the FOMC announced its commitment to keeping interest rates low for the foreseeable future. Below, bond yield curves are shown for U.S. treasuries with different maturation times. As trading prices are determined by investor demand, these are solid indicators of investor sentiment on the bond market.

Figure 25: 13-week treasury bill (orange) and 10-year treasury bill (blue) yields via Yahoo Finance 

The short-term treasury bill has taken one of the larger yield hits, dropping from trading above 1.5% to just over 0.125%. This drop indicates the more extreme effect that low interest rates have in the short-run on the markets. The mid-March pandemic market crash delivered its unilateral devastating consequences, and the 13-week treasury bill is now starting to operate at its post-crash level. As long as the Fed continues to hold rates low in the long-run, this short-run yield curve will continue to stay where it is. It is important to realize that short-run ramifications continue to persist even if the focus of the FOMC’s policy is longer term.

For a longer-term outlook, the bond yield for 10-year U.S. treasuries has dropped and hovered at 40% of its previous level before the WHO’s global pandemic announcement. While current news outlets are reporting that the consistent yield of the bond market means “the worst is over” for the economy, signs of an accelerated, V-shaped recovery are still nowhere to be found. The worst stretch may be over, but the consequence of that stretch is the operation of bond yields at a lower level. Although the 10-year treasury yield is not as severely impacted as the 13-week short-term yield, both observed simultaneous drops in the market crash and have behaved similarly based on outlook over the past few months. The longer term 10-year yield shows slightly greater curve ‘unevenness’ due to the additional uncertainty the long-term provides.

Falling interest rates directly dictate a fall in yields, regardless of the time horizon. The other directly correlated effect of the FOMC’s policy is the price of currently maturing bonds rising. If a bond was bought at the beginning of February 2020 (when both the 13-week and 10-year treasuries were trading at a 1.5%) a subsequent drop in return for current and future bonds would increase the value of the maturing treasury. If the current yield for the 13-week treasury bond is 0.1%, the market dictates that someone interested in buying a bond would have to pay fifteen times the price at the current yield level to get the same return as they would have received in February. This magnitude is amplified in the short-term but still rings true over the long-term. When the yield decreases, the price of a currently maturing treasury increases. 

The U.S. Bond ETF Market

Simple bond math principles show that when falling interest rates decrease yields, the price concurrently increases. The Fixed Income ETF market, which represents a diverse range of bonds in every sub-asset class of fixed income, provides a visual representation of that price increase since the FOMC’s announcement.

Figure 26 above, : iShares Corporate Bond ETF: Investment Grade (Pink) and High-Yield (Blue) (Source: Yahoo Finance). Below, Figure 27 Vanguard (pink) and PIMCO (purple) Total Bond Market ETFs (Source: Yahoo Finance)

Figure 28: Municipal Bond ETFs (Source: Yahoo Finance) Figure 29: SPDR Treasury ETFs (Source: Yahoo Finance)

(Investco I-G,VanEck H-Y)  

The ETFs used in these models are among the most prominent and common in the ETF world and provide a general estimate of the overall market behavior.

The Total Bond ETFs display similar pricing trends, with nearly identical patterns and dips from the Vanguard and PIMCO total bond market ETFs. Recovery since the mid-March market pandemonium, which sent all markets crashing down, has led to increased price levels of bond ETFs during that time. Upon breaking up the total bond market into subcategories as in the United States, similar patterns are revealed in most fixed income classes.

The US treasury ETFs, provided by State Street (SPDR) have the largest deviation from the total bond market pattern. Nevertheless, they all still show a clear increase in price over time. An early-March spike in the long-term treasury ETF price suggests that investors may have seen this crash coming, but when the crash became as bad as it did, people needed liquidity (zcheck). 

Corporate Bond ETFs display a similar pattern to the total bond market, with both Investment-Grade and High-Yield note ETFs seeing a significant increase in price since mid-March. The major difference on this plot is that the price of the investment grade ETF has risen above its levels before the market crash, whereas the high yield curve has remained below its pre-crash levels. There are a few reasons for this difference. The riskier nature of high-yield corporate bonds, combined with the unprecedented volatility and uncertainty in the corporate world, is the probable cause of the lower price level. Many investors are less likely to assume greater risk at this time, and this portion may cause overall investor sentiment to be more risk-averse.

Finally, the ever-changing and uncertain nature of what companies shape the structure of the ETF itself (ticker HYG) adds an additional layer of investor concern during this time. Despite any uncertainty, corporate bonds have been in high demand as a safe haven to the even more uncertain stock market. Between when the WHO declared Covid-19 a global pandemic and the end of April, corporations issued $265 billion in bonds, which is double the amount they issued in the same time in 2019. Additionally, the Fed’s official commitment to buy individual corporate bonds has bolstered the amount of funds in the market in the short term. 

Municipal Bond ETFs saw a similar trend to the total bond market ETFs, with price increases since the mid-March crash and the announcement to lower interest rates. For both high yield and investment grade, however, ETF price levels haven’t eclipsed pre-crash levels. This can again be attributed to the uncertainty factors mentioned with the high-yield corporate bonds, but also begins to show a pattern where investors may not even trust what the Federal Reserve is declaring.

Every sector of the U.S. Bond ETF Market has shown a significant price-increasing trend since the coronavirus threw the securities markets into disarray. While some have not yet surpassed the prices seen during the pre-crash time period, an eventual eclipse is anticipated based if the FOMC keeps their word. Currently maturing bonds will continue to appreciate in value, while the futures market becomes less and less tempting to enter for such a low return. 

The Wealth Gap

The wealth gap in the U.S. is already widely publicized and apparent. The country has the largest discrepancies between rich and poor of any developed nation, with the top 10% earning nine times that of the bottom 90% and the top 1% earning 39 times that of the bottom 90%. What is less publicized, however, is the great disparity in class participation in the investment market.

Figure 30: Net Worth by Percentile Group (Source: Money Crashers) 

The gini index — a ratio that measures income inequality — in the United States is .485, which is the highest it has been in the past 50 years. 

Recessions and market crashes have historically driven lower income families to withdraw their investments from the stock market, as seen in the dot com bubble of 2001. The rich, however, are financially able to hold onto their securities, meaning a boost to the stock market gives them a disproportionate level of returns. The FOMC’s commitment to low interest rates gives the stock market that push.

Figure 31: The Dow Jones (blue), S&P 500 (orange), Nasdaq (grey), Russell 2000 (yellow) have all grown at high rates since March 16th (Source: Yahoo Finance)

As the stock market section of this paper previously suggests, Figure 31 shows how every major stock market index has come storming back since the mid-March market crash due in part to the FOMC’s low interest rate policy. The benefits of this swell, however, are not evenly distributed across tax brackets. The top 1% holds over 50% of the money invested in stocks and mutual funds. This disproportionate allocation of investment market money means that those with more money in the stock market will benefit far more than the poor. 

Figure 32 (Source: a survey of 1,000+ people from Money Crashers)

Figure 32 shows the percentage of people investing in the stock market based on annual household income. This directional percentage sample shows in detail who is taking advantage of the policy effects of the FOMC. A major reason for this ascension in participation is the weight of different assets between class levels.

While higher income people are able to own a house and have money leftover to invest in the stock market without fear of losing a significant proportion of their wealth to stock losses, lower income people do not have this freedom and have fewer dollars to accumulate investment market assets. Further, the personal assets of lower income people — their house or car — hold a far greater proportion of their wealth than they do for the rich. Having more to lose and less to work with increases risk for lower income people far above the risk of those with higher income.

Expanding the wealth gap is obviously not the objective of the low interest rate policy, but Fed Chair Jerome Powell has said that the Fed simply has no choice and must conduct this type of monetary policy to get “the labor market back and getting it in shape.” Low interest rate policies increase investment and are a proven way to spur nationwide economic growth and combat periods of economic downturn within our economic system. When our economic system is pre-ladened with disproportionate levels of investment spending, however, the levels of income and wealth inequality are always going to rise.

A policy-supported stock market provides better support to those who are more deeply invested in it, and because the FOMC’s low interest rate policy aims to support the financial markets and spur investment spending, the wealth gap will widen.

Additional References : LONG-TERM LOW INTEREST RATES

Inequality in America was huge before the pandemic. The stock market is making it worse 

Income Percentile Comparison Calculator by Age 

Why wealth matters. The Global wealth report 

Wealth Inequality

Why a strong stock market increases inequality — Quartz 

A Month of Coronavirus in New York City: See the Hardest-Hit Areas 

Fed’s Harker Says Pandemic Is Worsening U.S. Inequality 

Who Rules America: Wealth, Income, and Power 


While low interest rates may help stimulate overall economic and market growth, retirees are a subgroup of the population that will likely be negatively affected by continuous low interest rates. Because low interest rates provide an incentive to spend rather than save–even making it increasingly difficult to save–those who rely heavily on interest income, like retirees, will be harmed. Focusing on data and analysis from the 2008 economic crisis, we will demonstrate that retirees will suffer, more individuals will move to and rely only on Medicare for health care coverage, and government agencies will implode.

Because retirees no longer have an income from work, they rely heavily on interest rates for a stream of income. Their cash flow comes from a combination of Social Security benefits, pensions, annuities, Treasury bonds, or other investments. However, investment returns will likely be lower in a low-interest rate environment. Lower interest rates over a long period of time make retirement income strategies difficult to pull off. The safe investment products retirees tend toward suffer in a low-interest environment. While unlikely that the finances of Social Security will greatly alter retirement benefits in the upcoming years, loss in value of T-bonds will likely lower the Social Security funds and income of retirees if the trends we will explore continue in the long-run..

First, it is important to understand what makes up the Social Security Trust Funds, which pays retirement, survivors, and disability benefits. Trust funds depend partially on interest earned on investments in Treasury bonds (T-bonds) and, by law, any surpluses must be invested in T-bonds. As a result, a given amount of trust funds income is generated by net interest.

Income generated by net interest, however, has been declining in recent years. According to the Social Security Administration’s Trust Fund Data, net interest income has been decreasing since 2009, right after the Fed cut rates to 0.25% in 2008. Despite the slight uptick in rates after 2015, the income continues to fall. 

United States Fed Funds Rate

Figure 33

Figure 34

As demonstrated in Figure 34, treasury yields rose dramatically between the mid-1960s and early 1980s as inflation climbed, then reversed course equally dramatically as inflation fell. But, even when inflation was fairly stable in the ‘90s and 2000s before the 2008 crisis, yields continued to fall significantly. Unsurprisingly, yields fell notably further during the crisis and recession after the Fed cut short-term interest rates and investors wanted a safe haven in turbulent markets. Yields then began rebounding to a very limited extent beginning around 2015, only to trend downward in 2019 as the low-interest rate environment continues.

Asset Reserves, or the accumulation over time of the difference between income and cost, also seem to be heavily impacted by low interest rates. While the total income and cost continue to increase, the rates at which these two increase are not consistent. The net increase during a given year has been decreasing since 2008, with an anomaly of an increase of $35,177M in 2016 to $44,103M in 2017. But, the two years after experienced a net increase of only $3,140M and $2,476M, respectively. As illustrated in the Income and Cost graph below (Figures 35-36), income growth since 2009 lowered after the financial crisis and during the Fed’s interest rate cuts. While information regarding the fiscal year 2020 is incomplete, we already see the difference in income and cost being $-7.5B in Q1, compared to a difference of $+6.5B in fiscal year 2019.

Click on graph to see income and cost amounts by quarter
click on graph for table on income, cost, and asset reserves

Figures 35-36 (Source: “Social Security Income, Costs, and Asset Reserves,” Social Security Administration)

It is important to note that the growth in costs and slowing growth of income is not in full due to the long-term low-interest rate environment. Changes in population growth, with birth rates dropping, also contribute to the depletion of asset reserves as the working class is smaller. As the large baby boom generation moves into retirement, there will be a substantial increase in costs; with lower fertility rates, this trend in costs is expected to continue without end. Still, however, as we will explore in the next section, the current low-interest rate environment exacerbates this already-occurring phenomenon.

United States Employed Persons
Figure 37: United States Employed Persons (Source: “United States Employed Persons,” Trading Economics)

Figure 38: BLS (Source: Torpey, “Older Workers”)

The still-large working class population in 2001 likely buffered the Asset Reserves when the Fed cut interest rates that year. We see in the Asset Reserves graph that there is no decrease in the Income and no leveling off of the Asset Reserves, unlike in 2008 and more recently in 2020. 

Beyond Social Security, another source of income for retirees that will be dramatically impacted by zero or negative interest rates is non-federal pension funds. While this area has not been studied in depth, it is an important consideration given the importance of pension funds: in 2013, pension funds reduced public assistance costs by $4B and kept one million retirees out of poverty. As Antolin et al found, lower interest rates increase the liabilities of pension funds. So, protracted low interest rates will lead to lower returns on portfolio investments.

The Impact of Coronavirus

The coronavirus pandemic made the job market bleak, with millions of Americans being laid off and finding a job difficult. This shock in unemployment and the Fed’s lowering interest rates to 2008 levels alters typical retirement patterns and retiree decisions. These decisions, as we will explore in greater detail in this section, include when to claim Social Security benefits and where to invest money for an income stream in retirement. Increased reliance on Social Security benefits will hasten the depletion of funds and retirees may turn to riskier investments for income.

United States Employed Persons
Figure 39: United States Employed Persons (Thousands) LONG-TERM LOW INTEREST RATES

The economic downturn due to panic related to the COVID-19 outbreak resulted in over 14 million Americans losing their jobs. As shown in the figure above, the labor market experienced a massive shock in few months. Some of the loss in jobs is due to the impact of state-mandated lockdowns and companies predicting a future loss in revenue. When a shock such as this one hits employment, many older workers nearing retirement decide to retire early.

A study by Congressional Research Service found that older workers who lost their job have a higher incidence of withdrawing from the labor market. Because of stay-at-home orders, older workers are one of the harder hit workers: retail trade and food services employ large numbers of low-wage older workers, but are also the sectors least amenable to virtual settings. Even if unemployed older workers decide to stay in the labor market. It will likely take longer for them to be reemployed (and they will likely face steep wage losses), as occurred in 2008.

Older workers who do choose to retire because of the unemployment shock then look toward steady, new sources of income. As in 2007, they will likely turn toward pensions and Social Security benefits. However, in a low-interest rate environment many will try to delay claiming benefits so as to improve their returns.

Previous research indicates that when someone decides to claim Social Security benefits is at least partially reliant on the interest rate environment. In a low-interest environment, people tend to claim benefits later than they do in a “normal” environment, one where the interest rates are near historical averages. As depicted in the graph below, the average benefit claiming age experiences an increase at times interest rates drop such as in 1999, 2001 and 2008.

Figure 40

The increasingly popular trend to delay claims is a beneficial decision for most given the persistent low-interest rate environment in the U.S.. Horneff, Maurer, and Mitchell (2018) compared the optimal claiming age for Social Security benefits and the optimal investments in a 401(k)-plan as well as in stocks in bonds for a “normal” and low-interest rate environment. This study found that, when interest rates–and expected returns–are high a worker can “claim early Social Security benefits without needing to withdraw as much from his retirement assets which continue to earn higher returns for a while longer.” But, in a low-interest rate environment a worker can “delay claiming Social Security in exchange for higher lifelong benefits”.

The findings of the study are corroborated by multiple others. Shovek and Slavov (2015) found that claiming benefits later is “actuarially advantageous for a large number of people”, even those with mortality rates two times higher than the average. But, when interest rates are close to historical averages, the same is not true. Cahill, Giandrea, and Quinn (2015) among others found similar results. 

However, the findings of Horneff et al (2018) as related to 401(k)-plan signify that there may still be a greater strain on Social Security despite delayed claiming. The table below (from Horneff et al) shows how wealth accumulation varies under different interest rates both inside and outside the 401(k)-plan. For example, in a 0% interest rate environment, women ages 65-74 optimally accumulate an average of $33,500 in a 401(k)-plan, whereas men an average of $27,400. But, in a 2% environment, women the same age accumulate $64,400 and men $63,100, an increase of nearly two times for both. For 401(k) assets, both men and women build up more wealth in a 2% yield than 0% yield environment.

Figure 41

In Non-Qualified Assets, or in liquid stocks and bonds, the opposite pattern exists. That is, if an individual puts money into liquid stocks, they will see greater wealth accumulation in a low-interest rate environment. Because of the risky nature of stocks, gaining assets through non-qualified assets favors the wealthy: or those who have enough assets to buffer a great loss through stocks. Seeing that gains are much greater in stocks than through 401(k)-plans in the current low-interest environment coupled with news of Social Security funds being depleted, workers will start devoting more of their savings to non-retirement accounts.

Even prior to the pandemic, the Social Security trust fund was expected to run out in 2034. But, the current health crisis is pushing up the expected date, as did the recession in 2008. As in the graphs below, the combined trust funds under intermediate assumptions were the same in 2007 and 2008, but pushed earlier by 4 years to 2037 in 2009. The fund’s depletion stands at 2035 according to the 2020 Trustees Report prepared prior to the pandemic. As in the 2008 recession, the pandemic is likely to push depletion to an earlier date.


Figures 42-44

COVID-19 has led to an inflation in unemployment and decrease in wages, all of which contributes to fewer taxes going to the Social Security funds. Of course, it is worth noting that, while estimates for fall 2021 exist, no one knows how long the pandemic will last nor how long its impact will last. Still, it is likely that COVID-19 will move the depletion of funds up slightly–but how dramatic that move-up is depends on shifts in wages and number of unemployed people. After a period of economic downturn (and the resulting low-interest rates), such as in 1991 and 2008, the projected years until depletion drops. Because we are not closer to the projected depletion, the current economic environment due to coronavirus may become a pressing issue.

Figure 45

As stated before, any shift in the projected depletion date is left to shifts in incoming taxes. More specifically, this shift will be decided by payroll taxes as they accounted for 89% of total OASDI income in 2019. As depicted in the graph, the number of Americans who have lost employment income is dramatic and will impact incoming payroll taxes. The Center for Retirement Research at Boston College found that if the COVID-19 collapse causes payroll taxes to drop by 20%, the depletion date will move up by 2 years. Another player in the drop of payroll taxes, and thus income for Social Security funds, is the executive action allowing the deferral, and possible forgiveness, of payroll taxes. This action in addition to the already existing COVID-induced layoffs are likely to push the depletion date up. 

                           Figure 46

The remaining 11% of income for Social Security funds come from a combination of income taxes on benefits and interest. Interest made up the bulk, nearly 9% of total income in 2019. As we have explored before, interest rates are already contributing to the declines in asset reserves and are not reliable to depend on for increased income given the current environment. Instead, as the Boston report states, when the pandemic comes to an end the fiscal policy of Social Security must be dealt with. Still, the only way to eliminate the existing long-run deficit is to find more money to put in or to start cutting benefits. 


We find explicitly positive correlations between rate-cut & stock market evaluation, where rate-cut boosts major indices (e.g. S&P 500) after a short-term of price decline due to market fear. The mid-cap ETF tends to perform the best among selected types of ETFs. We also detect the possible existence of bubbles in the stock market (very likely to be in the Tech sector.)


Reference for Figure 2:

Reference for Figure 3:

Sector Performance Comparison – Number of Winning Months

Below: Sector Historical P/E ratio (From 2006 Until Now)

Sector Historical Dividend Yield (From 2006 Until Now)

Below: Sector Bubble Detect Result Based on the Price Difference Quantile Threshold Method

(Other than Information Technology, Finance, and Real Estate that are shown above)

API Code – Example


Corina Perez-Cobb

Jason Kauppila

Qian Liu

Qian Pan


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