Somehow, it’s still controversial to suggest that rate hikes, and particularly the persistence of Fed funds at peak rates in the US, is fueling spending, prolonging the US expansion and, at least at the margins, putting a floor under consumer price growth.
To be clear, higher income households have a lower marginal propensity to consume, and it’s generally higher income households who hold interest-bearing assets. Notwithstanding the apocryphal grandmothers and uncles the Fed “robbed” of savings income by keeping rates glued to the lower-bound for nearly a decade after Lehman, everyday people don’t have extensive bond portfolios and the idea of poor people with large money market balances is a contradiction in terms. So, the enormous increase in interest income witnessed over the past two years has accrued largely to the already rich, for whom the inclination to spend incremental dollars isn’t as urgent.
That said, rich people still like to spend money. Otherwise why bother making more of it beyond what you need? And if you look at what’s done well recently (not “recently” as in last month, but rather over the last several years, and outside of tech), a lot of it’s luxury categories. I doubt that’s a coincidence.
My intuition is that when you deliver to people — any people, the poor, the already rich or anybody else — a huge amount of free money, you’re likely to get more demand. And when you take that money away, less demand. That’s sort of the whole idea behind fiscal stimulus, but we don’t extrapolate it to the monetary side. We probably should, though. It’s one argument for why (or, more precisely, for how) rate hikes can be inflationary and rate cuts conducive to a slowdown in consumption, or certain types of consumption.
With that in mind, have a look at the figure below from SocGen’s Andrew Lapthorne.
That gives you a sense of the “cashflow impact,” as Lapthorne put it, of the rate-hiking cycle stacked atop dividends and buybacks.
Investor income has “more than doubl[ed] from $2.2 trillion to over $5.1 trillion in just three years,” Lapthorne remarked. Higher rates, he went on, are “providing a massive cash flow boost to savers.”
Do note: Savers tend to… well, save when they run out of expensive handbags to buy, and those savings flows go into assets. Assets like stocks, real estate and so on, inflating their value, which in turn turbocharges “the wealth effect” for those fortunate enough to benefit from it.
In the latest Weekly, I argued that because the vast majority of Main Street doesn’t actually own many financial assets, the wealth effect’s largely irrelevant at this point in the cycle. Here’s how I put it:
Sure, the delirious market conditions that persisted in the go-go “stimmy” days of 2021 probably facilitated (over)consumption, but does that really apply in 2024 on an economy-wide basis? Or anyway to an extent that should’ve prevented the Fed from taking action to facilitate a soft landing? I tend to doubt it. More specifically, I tend to doubt the notion that the succession of warm CPI prints witnessed in Q1 of 2024 was the direct result of the November-December 2023 rally in financial assets, and as such I tend to doubt the idea that preemptive rate cuts earlier this year, whatever the impact on financial assets, would’ve left us any worse off on the inflation front versus where we are today.
At this point, keeping rates elevated is probably counterproductive. It’s just making the rich richer and the poor poorer without having much impact on inflation dynamics unless it’s in the wrong direction.
I should emphasize: This isn’t black and white. I don’t think it’s a situation where you either believe Warren Mosler or you believe everybody else and there’s no in-between. Rather, I think that as with all things, the truth’s somewhere in the middle. Higher rates can be inflationary — and no, that doesn’t mean Recep Tayyip Erdogan was “right all along” — but so can lower rates. It depends on circumstance. The devil’s in the details, so to speak.
But from a kind of common sense perspective, when you raise the rate on cash and fixed-income payouts such that you deliver to savers an extra $3 trillion over just three years, you should expect that at least some of that money will be spent. Unless you want to posit that the marginal propensity to consume out of interest income among the wealthy is actually not materially different from zero, an assertion I find implausible, to put it politely.
Construction in the 1980s showed me that that is absolutely the case.
Poorer customers wanted repairs and to somehow extend until times got better Or they got their tax refund.
Country club set were upgrading on whims and gave me the sense that they were somehow being charitable to me and my workers. Paying with money market checks. The whole trickle down economy notion was over martinis at country clubs.
Trickled down economy is the ultimate wasp nonsense.
We truly have a K-shaped economy. High rates help the upper half and hurt the lower half, low rates have the potential to help the entire economy. So the people in the lower half have to be thinking, “thanks for that fiscal stimulus money….and then, I really did not appreciate you allowing it to be “inflated away”.”
I wonder if cutting rates could lead to a different sort of inflation…
As you’ve written plenty of times before, the original concept of QE–as explicated by Bernanke in the WSJ and elsewhere–was to push money into the real economy by injecting it into financial markets. The “transmission mechanism” from financial markets to real goods and services, however, was “clogged.” As such, the only significant inflation created by QE was of financial assets. Real-world inflation remained moribund.
Now, with QT winding down and rates being cut over the next cycle, a lot of the money currently parked in MM funds will presumably go looking elsewhere in the never-ending hunt for yield. Just as it’s safe to assume the wealthy will spend at least some of the extra investment income they’re receiving, it’s safe to assume some of the money parked at 5.3% will go elsewhere when that drops to 3.5%.
Much as was the case during all previous episodes of QE, the transmission mechanism out of financial markets will remain clogged, so AUM leaving MM will instead chase alternative financial assets, once again serving as a source of financial market inflation. Maybe.
That’s a good question – a LOT of money was flowing in the VC space during the Covid years leading to massively inflated valuations in early-stage tech companies which also created an ecosystem of companies buying from each other that helped sustain those valuations. Now that the music stopped, valuations have plummeted for most non-public tech companies as everyone in the space cuts back spending. We are still in an unwinding phase as those companies start running out of cash and do everything they can to sustain themselves.
Will those early stage investors come back once that money needs to find more lucrative channels or will they be more hesitant this time around knowing rates can go back up and wipe out their speculative tech bets? I don’t think the money will come rushing back in as many of those investors are still tied up in bad bets from the Covid era. I have no idea where else it might go though.
I tend to think that lower rates would have a much larger effect on housing/construction inflation than higher rates would. You’re not buying property from your 5% interest unless your bond portfolio is massive (20m+). But even then, if you’re that person, then you probably have stocks too and you’re probably not looking at 1-2m properties, you’re interested in more expensive 2nd homes in luxury markets. So I have a hard time seeing how high interest rates contribute much to rising housing asset prices and construction inflation. Also, 40% of Americans own their homes outright (boomers mostly?) making rates a non-issue, as we’ve seen.