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A proposal to use two interest rates in the U.S.; the FED Funds Rate and the Economic Recovery Rate

De Koning, Kees (2021): A proposal to use two interest rates in the U.S.; the FED Funds Rate and the Economic Recovery Rate.

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Abstract

The Federal Reserve has indicated that it will gradually reduce its purchases of eligible securities (Quantitative Easing) from November 2021. At the same meeting of the Federal Reserve Board, the Committee members who decide when to start raising interest rates were split equally about a possible starting date. The current guidance rate is between 0% and 0.25%. If the guidance rate is changed, the banking sector follows.

An element that needs further attention is how an interest rate rise would affect households and thereby employment levels, profit levels of companies and the tax receipts of the U.S. Government.

Take mortgages as an example. A mortgage represents the encumbered element of a home. The second element is the home equity savings element. In case of an increase in base rates, the financial sector can be expected to follow up with an increase in mortgage rates. The borrowers will have no choice but to pay up.

There is another option that focuses on the savings element in U.S. home equity, currently estimated at $23.6 trillion. Treating home equity savings as a key to economic expansion needs a system that helps households to temporarily reduce some of such home equity and use it for funding its consumer spending levels.

The financial sector cannot lend funds at 0% as they borrow their funds at market rates. However, the Fed can do so by introducing not one but two different rates: one the Fed funds rate, which influences the rate for the financial, commercial and Government borrowing sector and the second one for a temporary release of some home equity for households; the Economic Recovery Rate (ERR). The latter –a 0% rate- can be applied as a micro and equally a macro economic tool to stimulate the U.S. economy as and when needed.

Why and how such dual interest rate system could work is explained in this paper.

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