How Long Will Interest Rates Stay High?

on Aug8
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Dr. Alice Mills was thinking of selling her veterinary practice in Lexington, Ky., this year, but she decided to put the move off because she worried that it would be difficult to sell in an era of rising interest rates.

“In a year, I think that there’s going to be less anxiety about the interest rates, and I’m hoping that they’re going to go down,” Dr. Mills, 69, said. “I have to put my faith in the fact that the practice will sell.”

Dr. Mills is one of many Americans anxiously wondering what comes next for borrowing costs — and the answer is hard to guess.

Whether that proves to be the case will have big implications for American companies, consumers, aspirational homeowners and policymakers alike.

Kristin Forbes, an economist at the Massachusetts Institute of Technology, said it was important not to be too precise about guessing the neutral rate — it moves around and is hard to recognize in real time. But she thinks it might be higher than it was in the 2010s. The economy back then had gone through a very weak economic recovery from the Great Recession and struggled to regain its vigor.

“Now, the economy has learned to function with higher interest rates,” Ms. Forbes said. “It gives me hope that we’re coming back to a more normal equilibrium.”

Many economists think slightly higher rates would be a good thing. Before the pandemic, years of steadily declining demand for borrowed money depressed rates, so the Fed had to cut them to rock bottom every time there was an economic crisis to try to encourage people to spend more.

When fewer people need houses and products, there is less demand for money to borrow to construct buildings and factories, and interest rates naturally fall.

Such factors are enough for Mr. Williams, the New York Fed president, to expect neutral rates to stick close to their prepandemic level. He also pointed to the shift toward internet services: Streaming a movie on Netflix does not require as much continuing investment as keeping video stores open and stocked.

“We are moving more and more to an economy that doesn’t need factories and lots of capital investment to produce a lot of output,” Mr. Williams said, later adding that “I think the neutral rate is probably just as low as it was.”

That has some big implications for monetary policy. When inflation of around 3 percent is stripped out, the Fed’s policy rate sits at about 2.25 to 2.5 percent in what economists call “real” terms. That is well above the setting of 1 percent or less that Mr. Williams sees as necessary to start weighing on the economy.

If price increases continue to fall, the Fed will inadvertently be clamping down on the economy harder in that “real” sense if it holds its policy interest rate steady, Mr. Williams said. That means officials will need to cut rates to avoid overdoing it, he said — perhaps even as soon as early next year.

“I think it will depend on the data, and depend on what’s happening with inflation,” Mr. Williams said when asked if the Fed might lower interest rates in the first half of 2024. “If inflation is coming down, it will be natural to bring” the federal funds rate “down next year, consistent with that, to keep the stance of monetary policy appropriate.”

For Dr. Mills, the Kentucky veterinarian, that could be good news, bringing partial retirement that much closer.

“I would love to get back into zoo work,” she said, explaining that she had worked with big cats early in her career and would love to do so again once she sold her practice — which is itself cats only. “That’s something for retirement.”

Audio produced by Parin Behrooz.

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