Mar 6, 2023 - Economy & Business

Theories for why rate hikes pack less punch

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Illustration: Maura Losch/Axios

On Friday, Axios looked at the strange situation facing the economy: Conditions are as robust as ever, despite the Federal Reserve's best efforts to slow demand and bring down inflation with aggressive interest rate hikes.

  • We raised a range of possibilities for why rate hikes aren't packing the same punch they have historically. That includes the shifting structure of the economy, the mechanics of financial markets, and higher wealth inequality.

Yes, but: Readers had lots of ideas of their own. Now we look at some of your theories on why tighter money isn't really translating into a slower economy (plus one from a top Fed official who was asked about it over the weekend).

What you're saying: "You seem to ignore the most basic reason why the economy has not slowed down more yet," Brad B. wrote us. "There is a 6-12 month lag effect correct?"

  • Yes, absolutely. Monetary policy famously does work with long and variable lags, just as Brad describes. It is entirely possible that rate hikes will start to pinch more as 2023 progresses, and this whole question will be moot.
  • That said, it's worth noting that some research points to those lags getting shorter given the ways the Fed now communicates its future intentions. And by that measure, this tightening campaign began in November 2021, a whopping 17 months ago.

Reader Erica P. writes, "I've wondered whether the seeming ineffectiveness of U.S. monetary policy has to do with the robustness of current fiscal policy."

  • "The federal government is spending a lot of money on infrastructure, which offers stability — in the form of lucrative government contracts — to a lot of different kinds of businesses for the coming years," she says.
  • There was indeed massive federal pandemic relief in 2021 that could still be influencing the economy; consumers with pent-up savings from that era, for example, and state and local governments still flush with federal grants.
  • At a minimum, the government is not implementing any kind of austerity agenda that might bring inflation down.

Ron L. of Baltimore writes, "I suspect that the Fed's actions have the desired long-term effect while having the opposite of the desired effect in the short term. Buyers want to buy before prices increase even more. For sellers, making the sale now outweighs getting a slightly higher price later."

  • Another reader, Dwight T., argues that they were too slow. "When I run the numbers it is largely that the Fed has wanted it both ways (booming economy and low inflation) and they just started raising rates late," he writes. "If they had started rate increases a year earlier … it would probably have been quicker."

Finally, at an event at Princeton on Saturday, Harvard's Jason Furman asked San Francisco Fed president Mary Daly for her thoughts. "Is monetary policy losing its effectiveness because there's fewer interest-sensitive sectors?" Daly pondered. "I think that's worth continuing to think about."

  • That said, Daly went on, "I think it's too early to say that it's not working."
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