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Can High Rates Stoke Inflation? Ask $3 Trillion
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 saving
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.