Could interest rate hikes be keeping inflation high?

The persistence of post-pandemic inflation has raised questions about how effective high interest rates are in curbing price increases, and whether they are fueling the problem.

Standard economics holds that higher interest rates should squeeze the labor market, reduce demand for goods and services, and therefore lower prices. When demand decreases, companies are forced to lower prices.

Inflation began to decline rapidly in mid-2022, but remained above 3% for nearly a year, rising to 3.5% in March. Some experts are now questioning the logic behind the rate hikes, questioning whether they are stimulating the economy toward further growth rather than slowing it down.

For it to work, the extra money earned in the form of interest income from rising interest rates needs to flow back into the economy through consumer spending, thereby further spurring price increases.

Investors and asset managers say they are seeing signs of this happening.

“People who have piles of cash are generating cash faster than they can spend it,” Ritholtz Wealth Management CEO Josh Brown told the CNBC television network last week.

“I work in wealth management…and let me tell you, not only are people in this demographic not leaving because of higher interest rates, they are often doing better than they have in the past. I feel that there is.”

The Fed is poised to keep interest rates within its current range of 5.25% to 5.5% at its next policy meeting in May, following some strong employment and inflation reports. Federal Reserve Chairman Jerome Powell said last week that the Fed had not yet seen the desired “progress” in combating inflation and was prepared to keep interest rates high for an extended period of time.

“Recent data shows solid growth and continued strength in the labor market, but so far this year we have not seen further progress returning to the 2% inflation target,” Powell said in a panel discussion last week. It also shows that.”

But some experts worry that the Fed’s decision runs counter to its goal of slowing the economy to low inflation.

“[The Federal Reserve] Investor David Einhorn, founder of hedge fund Greenlight Capital, said this on a Bloomberg podcast in February. “I think that’s why we’ve had very strong GDP growth that continues to occur.”

Federal debt levels are currently at record highs, with U.S. Treasury yields hovering above 4.5% and near a 20-year peak, further fueling the move and forcing billions of dollars more into bondholders. There is a possibility that it will fall into the pocket of

“If interest rates are around 4%, you’re paying more than 4% of GDP in interest,” Einhorn said. “So you end up paying a large portion of the taxes you collect in debt service before you actually get what you want.”

The idea that rising interest rates may actually be stimulatory rather than restrictive is part of modern finance, which argues that government deficits are the norm of fiscal policy rather than the exception to it. This has been a long-standing belief of theorists (MMT).

MMT economists note that gross domestic product (GDP) growth has accelerated over the past year as interest rates have risen.

“Are we at a tipping point where interest payments are in the hands of a lot of people and we’re starting to veer into an economy where supply can’t keep up and we’re starting to spend interest? You can count on it,” Stony Brook University economist and MMT supporter Stephanie Kelton said in an interview with The Hill in February.

“We’ve seen inflation continue to fall while growth accelerates. If the Fed’s rate hikes are really working. [Fed chair Jerome] Powell [has tried] To convince us that they are, they have to rack their brains and ask, ‘How do you define working? ” you have to ask. ”

These are currently open questions in the economy, as government data does not track how much interest income is reflected in consumer spending.

Commerce Department officials told The Hill it’s impossible to measure how much consumer spending comes from interest, compensation, dividends and other sources. The Fed did not respond to this article’s questions about the relationship between interest rates, spending, and demand levels.

Fed officials have previously acknowledged that higher interest rates could lead to higher prices in interest rate-sensitive sectors of the economy, particularly housing costs.

but, personal interest income has accelerated since 2021 and is now near all-time highs.

Other economists dispute the idea that interest income may be boosting demand and suspect the effect is small.

“We estimate that the amount of additional consumer spending spurred by higher interest payments is relatively small,” said Dean Baker, an economist at the Center for Economic Policy Research, a think tank. Baker told The Hill. “Most interest income doesn’t go directly to people. It goes to pension funds and banks, but when it does go to people, it’s primarily through holding 401(k)s and other retirement accounts. I will.”

However, pension funds Transfer of funds As returns increase, investments in bonds are increasing from the stock portfolio.

“Pension funds may be reallocating money from stocks to bonds because they are finally able to capture yield in the bond market,” said investor Axel Merck, founder of Merck Investments. . . . because you don’t have to chase it anymore,” investor Axel Merck, founder of Merck Investments, told The Hill.

If interest income is indeed the driver of inflation, the fact that only a small portion of U.S. households actually earn money from interest makes it easier to use interest rate hikes to slow economic activity. The Fed’s logic could be even more controversial.

Less than one-fifth of U.S. households have income from interest, dividends or rental income, according to Census Bureau data.

“Maintaining the unequal pain of rising interest rates could hurt lower-income groups for a long time while helping higher-income groups,” UBS economist Paul Donovan said in a note to investors on Friday. Yes,” he said.

“Oddly enough, for the top 10% of households by income or net worth, very high yields may actually prove to be exciting,” said Josh Brown of Ritholtz.

The extent to which the exorbitant profit margins made possible by fiscal stimulus are contributing to inflation has spurred debate, but this also concerns the current state of the economy, as pointed out in the recent Fed Beige Book. Although this is an open question, the trend appears to be on the decline.

“The Fed’s Beige Book anecdote strongly suggested that consumer revolt was reversing profit-driven inflation. But an anecdote of benign inflation does not automatically lead to a decline in headline inflation. “It’s controlled, manufactured prices that support inflation, not market-determined prices,” Donovan said.