Low interest rates are good for borrowers because it means that it costs less for them

to borrow. But low interest rates are bad for savers because it means that they earn

a lower return on their savings. Similarly, high interest rates are bad for borrowers

because it means that they must pay more to borrow money. But, high interest rates are

good for savers because it means that they earn more interest on their savings. In 1972,

mortgage rates were 7 percent and the average American household's debt was 76 percent

of its income. Mortgage interest rates rose until 1981 and then fell.

As mortgage rates rose, people borrowed less. And as mortgage rates fell, people borrowed

more. Today, mortgage interest rates are almost half of what they were in the 1970s, allowing

households to borrow about twice what they could afford then. Some argue that we need

interest rates to be low so as to encourage spending. But, low interest rates don't

simply encourage people to spend more. They encourage people to spend more now in exchange

for spending less in the future. Since borrowed money must be paid back, the additional spending

that goes on today will be offset by lesser spending in the future when people pay back

their loans. Similarly, high interest rates don't simply encourage people to spend less.

They encourage people to spend less now in exchange for spending more in the future.

So what is the right interest rate?

The answer is the free market interest rate. The free market interest rate is the rate

we get when the Federal Reserve does not interfere in financial markets. Individual borrowers

and savers know better than the Federal Reserve whether they should give up spending tomorrow

in exchange for more spending today or whether they should give up spending today in exchange

for more spending tomorrow. When the Federal Reserve actively manages interest rates it

replaces these people's judgments about what's best for them with the Federal Reserve's

judgment as to what's best for them. The lesson is that borrowing and saving are really

about deciding whether to consume more now and less later or more later and less now.

And these decisions are best left to individuals.