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Mensen die met mondkapjes op boodschappen doen in de supermarkt

Interest rates in the euro area are at a historic low. At De Nederlandsche Bank (DNB) we expect them to remain low for some time to come. Research has shown that interest rates have trended downward for the past few centuries. Especially since the eighties, they have fallen sharply. What are the consequences of low interest rates, and how to they affect our daily lives?

What is interest?

Interest is the price we pay when borrowing money or attracting savings. As with all products, it is the relation between supply and demand of money in the market for loans and savings that determines its price – the interest rate. If savings are in great supply or if there is little demand for loans, interest rates are low. Changes in the relation between supply and demand are subject to long-term trends that even the European Central Bank (ECB) cannot change. Globalisation, population ageing and a cautious attitude among consumers and firms have boosted savings across the worlds. On top of that, the COVID-19 crisis has increased the propensity to save. The demand for loans has gone down as a result of lower public investment and the growing share of the services sector in the Dutch economy. Firms in the services sector – such as law firms, plumbers and IT companies – need fewer investments than, for instance, manufacturing businesses. This explains, together with the drop in inflation, why interest rates have gone down. The ECB’s monetary policy has been highly accommodative for some time in order to stimulate inflation, resulting in a further decline in interest rates. During the COVID-19 crisis, the ECB has taken further steps to ensure the economy can continue to run smoothly. Historically low interest rates influences many key areas. It influences our savings, our mortgage loans and our pensions.

Infographic about low interest

So how exactly do low interest affect our daily lives?

The low interest rates affect all of us either directly or indirectly. Just consider these examples:

  • Setting your money aside will earn you less in interest, but taking out a loan to purchase a home will also be cheaper.
  • With money now available at such a low price, mortgage loan amounts have risen, as have house prices. Similarly, investors are increasingly keen to purchase residential properties, with savings now earning little in interest. At the same time, low interest rates offer the Dutch government a window of opportunity to curtail mortgage interest tax relief with relatively little adverse consequences.
  • Low interest rates makes saving up for retirement more expensive. This is because pension funds cannot earn as much as they used to on their investments. Although they have been able to capitalise on surging stock prices over the past few years, they have seen their funding ratios  go down as their liabilities increased at an even faster rate. In the end, this leaves them unable to ensure that pension benefits keep up with the higher cost of living by means of indexation. They might even have to curtail pension benefits.
  • The government has more budgetary leeway. As the government sees its interest charges go down, it can refinance debt and take out more at low costs.
  • Most banks experience higher demand for loans and credit, but over the longer run they may see their interest income dip below the amount in interest they owe on savings accounts.
Read more about learning to live with low interest rates in our 2019 Annual Report

A quick overview of the consequences of low interest rates

Put briefly, the consequences of low interest rates are:

  • Firms’ investments have become cheaper.
  • Households have been able to borrow more cheaply to acquire a home or other purchases.
  • House prices are rising, as are shares.
  • The Dutch government has more leeway for additional expenditure.
  • Savings earn less in interest.
  • Pension funds and insurers have less cash to pay out pension benefits and insurance claims.

What are the consequences for the future?

The current low interest rates give rise to many questions. How do we deal with high house prices and pressure on pension funds? What do low interest rates mean for the government's budget margins? And how much further down can interest rates go? The ECB is currently reviewing its monetary policy approach. These questions are part of its review.