High interest rates for a prolonged period usually push the U.S economy into a recession. But not this time around — at least not yet.
After a string of hikes, which took the benchmark Federal Funds rate from almost zero three years ago to 5.50%, the U.S economy remains resilient.
In the third quarter of 2023, the Gross Domestic Product (GDP) grew at an annual rate of 4.9%, the highest reading since the last quarter of 2021, ahead of market forecasts of 4.3% and a 2.1% expansion in the second quarter.
It’s a mystery defying the chorus of Wall Street analysts calling for a recession as soon as the hikes began 18 months ago. But there are a few reasonable explanations for this mystery. First, monetary policy works with time lags, meaning it takes several months before interest rate hikes work through the economy, though eighteen months is already too long.
Second is the historically low unemployment rates, thanks to the Biden administration’s massive infrastructure spending plan and the pend-up demand for leisure services during the Covid-19 pandemic. They provide jobs to low-income households with a marginal propensity to consume.
In the third quarter of 2023, consumer spending rose 4%, up from 0.8% in the previous quarter, the most since the fourth quarter of 2021. More recently, a retail sales report showed that sales at the nation’s retailers grew at an annual rate of 2.5%, more robust than the market expectations of 2.1%.
“The primary reasons high-interest rates have not yet pushed the economy into a recession are the historically low unemployment rate of 3.9%, David I Kass, Clinical Professor of Finance at the University of Maryland, Robert H. Smith School of Business, told the International Business Times.
Sean Casterline, a Wealth Manager for the Investment Advisory firm in Orlando, Florida, Delta Capital Management, agrees. “The main reason higher rates haven’t pushed the economy into recession is that the unemployment rate is so low,” she told IBT. “Americans have jobs, and when they have money, they spend it. Retail sales have been what’s kept this economy afloat.”
“Currently, we have observed a solid labor market with historically low unemployment rates, which implied higher aggregate supply and therefore higher GDP with no recession,” added Dr. Tenpao Lee, professor emeritus of economics at Niagara University. “In the meantime, geopolitical tensions increased agricultural and energy prices, which also encouraged more U.S. exports in these sectors.”
Professor Kass sees another set of macroeconomic factors that have helped American households keep on spending money, like a shallow average home mortgage rate of 3.8%; consumer balance sheets with large cash balances from the recent monetary and fiscal stimulus in response to the pandemic; relatively little consumer debt as compared to the Great Recession (2007-09); and the Consumer Price Index (CPI) and the Core Personal Consumption Expenditures Index (less food and energy) currently at 3.7% down substantially from 9.1% in June 2022 (CPI).
He’s also pointing out that previous recessions resulted from the Federal Funds rate being increased to much higher levels than the current 5 1/4% – 5 1/2%.
Pawan Jain, Ph.D., associate professor, and interim chair of the VCU Department of Finance, Insurance, and Real Estate, observes that the current cycle of interest rate hikes has been gradual rather than aggressive (as was the case in the early 1980s). “It gives the economy more time to adjust, potentially avoiding a sharp downturn,” he said.
Will Matheson, Co-Founder and Managing Partner at Matheson Capital, subscribes to another narrative. He believes that the U.S economy has yet to slide into a recession because rising interest rates do not directly impact roughly 80% of the economy. “Federal, state, and local government spending plus healthcare combine for roughly 50% of the economy, and those sectors are largely unaffected by interest rates,” he said.
He thinks the same is true for the real estate sector, where most mortgages are fixed.” Unlike the lead-up to The Great Recession when many homeowners were using adjustable-rate mortgages, 80% of American mortgage owners have fixed rates below 5%, so rising rates aren’t impacting their monthly payments,” he explained.
Collin Plume, founder, and CEO of Noble Gold Investments, believes that we aren’t in recession because we changed the definition of recession to ensure we don’t go into recession. “A recession is generally defined as two consecutive quarters of negative gross domestic product (GDP),” he told IBT. “If we are to follow this definition, a recession started in the summer of 2022.”
“However, the organization that defines U.S. business cycles, the National Bureau of Economic Research (NBER), defines recession differently,” he continued. “They take it to mean a significant decline in economic activity spread across the economy and lasts more than a few months.”
