6 months ago • 1 min
Ever since last year, when central banks started trying to combat high inflation with aggressive interest rate hikes, people have been warning about an impending recession. But even now, with interest rates across the US, UK, and Europe at 20-year highs, that highly anticipated downturn remains elusive. Here are three reasons why the recession seems to be late, and why we might need even higher interest rates to tame this inflation beast:
Reason 1: Consumers have a big pool of savings to tap into, thanks to trillions of dollars’ worth of government-assisted pandemic payouts. Higher interest rates usually mean higher borrowing costs, leading consumers to rein in spending pretty quickly. But a higher savings rate means consumers can keep spending as long as they have a nice cash cushion to fall back on.
Reason 2: Governments are still spending – by the trillions, in fact. Just take a look at the recent US Inflation Reduction Act signed last year, providing close to $500 billion in new spending and tax breaks that will go toward clean energy and climate change initiatives, or the $1 trillion US infrastructure bill passed in late 2021. Consumers might eventually feel the pinch from higher rates, but government spending could very well offset most of the demand crunch.
Reason 3: Interest rates may seem high, but real (inflation-adjusted) interest rates in the US have only recently inched into positive territory (blue line) recently. And in Europe, rates are still in the negative, even though the European Central Bank hiked rates to a lofty 3.5% in June. What that means is that nominal rates can probably go even higher still before these economies get knocked off course…
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