We are in the midst of a long-term trend of declining interest rates. Despite recent headlines about high rates following the Fed’s tighter policies since 2022, inflation-adjusted, or “real” interest rates, have been falling since at least the 1980s.
On the surface, lower rates seem like good news for the economy. Most people assume that cheaper borrowing benefits everyone. But research from Duke University’s Fuqua School of Business suggests that lower interest rates may actually be contributing to income inequality and reduced economic mobility.
Rate drops
The researchers argue that as rates drop, wealthy families are shifting their investments away from financial assets like stocks and bonds and toward their children’s education. This change could be widening the income gap and making it harder for the next generation to move up the economic ladder.
Their hypothesis is that wealthy parents treat their children’s education like part of their investment portfolio. They see education as a way to ensure their children’s future success, much like they view stocks as a way to grow their wealth.
It’s hard to prove that falling rates directly cause rising inequality, the authors admit. But they show that when interest rates fell in the past, the gap between how much rich and poor families spent on education grew. In the 1960s, when rates were low, wealthy families spent much more on education than poorer ones. That gap shrank in the 1970s as rates rose, only to widen again in the decades since as rates steadily declined.
“The data shows a clear pattern: as interest rates go down, the education spending gap between rich and poor families grows,” the researchers say.
Returns on investment
Wealthier families began to see better returns from investing in education than from financial assets, so they poured more money into their children’s schooling. In theory, lower interest rates should make education more accessible to poorer families, making it easier to borrow for student loans. But in practice, poorer families face borrowing constraints—they can’t access enough credit to invest in education, even when rates are low.
“They want to borrow more, but government limits or banks’ lending practices hold them back,” the researchers explain. “It’s similar to the housing market, where poorer families struggle to get loans despite low rates.”
As a result, rich families increase their educational spending, while poorer families can’t keep up. This rising demand for education from the wealthy also drives up tuition costs, making it even harder for lower-income families to afford college.
The study found that over the past 60 years, household spending on education has increased as a share of total spending. But the rise has been far greater for wealthier households. The researchers built a model to explain this. It assumes all parents want to do what’s best for their children. Wealthier families have more flexibility to choose between saving money, spending it, or investing in education. Poorer families, however, face borrowing limits that prevent them from making the same educational investments, even though lower interest rates should, in theory, help them.
The findings suggest that lower interest rates may have contributed to a 17% increase in labor income inequality and a 7% drop in economic mobility, meaning children’s future earnings are more tied to their parents’ income than before.
“We’re only looking at direct spending on education, but rich families also invest in other ways—like private lessons or spending more time with their kids, which boosts their future success,” the researchers note.
Access to jobs
Without better access to education, children from poorer families may miss out on high-paying jobs they are qualified for, while children from wealthier families, who may not need college as much, end up with the best opportunities.
An inefficient allocation of resources—where talented children don’t get the education they need—hurts both growth and equality.
Several factors have driven the decline in interest rates. Slowing economic growth has led people to save more, which pushes down returns on financial investments. People are living longer and need to save for retirement, further lowering rates. Foreign investment in U.S. assets, or the “global savings glut,” has also driven rates down.
While central banks have raised rates recently to fight inflation, the long-term trend is likely to continue as economic growth slows and populations age. If the researchers are right, inequality could worsen in the coming years, raising concerns for policymakers.
The authors question whether taxes could help counter these effects. A wealth tax might backfire by lowering financial returns, further encouraging rich families to invest in education. Instead, they suggest that labor income taxes might reduce inequality without these unintended side effects.
“At the very least, any tax should be paired with a redistribution plan to share the revenue,” they conclude. “But some taxes work better than others when you consider how interest rates influence educational investment.”
