dr Alice Mills considered selling her Lexington, Kentucky, veterinary practice this year, but decided to postpone the move because she feared the sale would be difficult in a time of rising interest rates.
“A year from now I think there will be less concern about interest rates and I hope they will come down,” said Dr. Mills, 69. “I have to have faith that the practice will sell.”
dr Mills is one of many Americans worried about the future of borrowing costs — and the answer is hard to guess.
It’s expensive to borrow money to buy a business or a car in 2023. Or a house: Mortgage rates are about 7 percent, up sharply from 2.7 percent at the end of 2020. That’s the result of the Federal Reserve’s campaign to cool the economy.
The central bank has hiked interest rates to a range of 5.25 to 5.5 percent – the highest level in 22 years – which has worked to raise the cost of borrowing across the economy. The goal is to discourage demand and force sellers to stop raising prices as much, thereby curbing inflation.
But almost a year and a half after those efforts began, the Fed is nearing the end of its rate hikes. Officials have forecast just one more increase, by a quarter point, in 2023, and Federal Reserve Bank of New York President John C. Williams said in an interview that he sees no need for more.
“We’re pretty close to peak interest rates and the real question is going to be – once we get a good grasp of that – how long do we have to keep policy on a tight stance and what does that mean?” Mr Williams said on April 2. August.
The economy is nearing a tipping point, with many consumers wondering when interest rates will fall again, how fast, and by what extent.
“Ultimately, monetary policy has to return to more normal policy – whatever that normality may be – over the next few years, to a more normal policy attitude,” Williams said.
So far the jury is out on what “normal” means. Fed officials expect to cut rates next year, but only slightly — they think it could take several years for rates to return to levels between 2 and 3 percent, like their peak in previous years the pandemic. Officials don’t expect mortgage rates to drop to near zero in 2020 like they did back then.
That’s a sign of optimism: rock-bottom interest rates are only seen as necessary when the economy is in bad shape and needs to be revived.
In fact, some economists outside the Fed believe borrowing costs may remain higher than they were in the 2010s. This is because what has long been known as the neutral interest rate – the point at which the economy is neither stimulated nor depressed – may have risen. This means that today’s economy may be able to handle a higher interest rate than it could previously handle.
A few big changes could have caused such a shift by increasing demand for borrowed money, driving up the cost of borrowing. These include that the government has accumulated increasing debt in recent years, that companies are increasingly switching to domestic production – potentially increasing demand for factories and other infrastructure – and that climate change is increasing the need for green investments.
Whether this is the case will have major implications for American businesses, consumers, aspiring homeowners and policymakers alike.
Kristin Forbes, an economist at the Massachusetts Institute of Technology, said it’s important not to overestimate the neutral interest rate — it fluctuates and is difficult to spot in real time. But she thinks it could be higher than it was in the 2010s. The economy had then experienced a very weak economic recovery from the Great Recession and was struggling to regain momentum.
“Now the economy has learned to function with higher interest rates,” Ms Forbes said. “It gives me hope that we are returning to a more normal balance.”
Many economists think that slightly higher interest rates would be a good thing. For years before the pandemic, steadily falling demand for borrowed money depressed interest rates, so whenever there was an economic crisis, the Fed had to cut rates to rock bottom to encourage people to spend more.
Even near-zero interest rates weren’t always enough: growth was slow to recover after the 2008 recession, despite the Fed’s extraordinary efforts to revive it.
If the demand for money is regularly slightly higher, it becomes easier to stimulate the economy in difficult times. When the Fed cuts interest rates, it will drive more homebuyers, entrepreneurs, and car buyers out of the market. That would reduce the risk of economic stagnation.
Certainly, few, if any, prominent economists expect interest rates to remain at higher levels than prevailed in the 1980s and 1990s. Those who expect rates to stay elevated think the Fed’s interest rate could be around 4 percent, while those who expect lower rates see something closer to the 2 to 3 percent range, Joseph Gagnon said , Senior Fellow at the Peterson Institute for International Economics in Washington.
That’s because some of the factors that have caused interest rates to fall in recent years remain — and could intensify.
“Some of the explanations for the fall in long-term interest rates before the pandemic hit are still there,” explained Lukasz Rachel, an economist at University College London, citing things like an aging population and low birth rates.
When fewer people need homes and products, there is less demand for loans to construct buildings and factories, and interest rates naturally fall.
Such factors are enough for New York Fed President Mr. Williams to believe that neutral interest rates will remain close to their pre-pandemic levels. He also pointed to the shift toward internet services: Streaming a movie on Netflix doesn’t require as much ongoing investment as keeping video stores open and stocked.
“We’re moving more and more toward an economy that doesn’t need factories and doesn’t need big capital investments to produce much,” Mr. Williams said, later adding, “I think the neutral interest rate is probably as low as he is.” was.”
This has some major implications for monetary policy. Factoring out inflation of around 3 percent, the Fed’s policy rate is around 2.25 to 2.5 percent, which economists call “real.” That’s well above the 1 percent or less threshold that Mr. Williams believes is necessary to stimulate the economy.
If inflation falls further, the Fed will inadvertently contain the economy harder in that “real” sense if it keeps interest rates steady, Mr Williams said. That means officials will have to cut rates to avoid a hype, he said — maybe even as soon as early next year.
“I think it’s going to depend on the data and what happens with inflation,” Mr Williams said when asked if the Fed might cut interest rates in the first half of 2024. “Of course, if inflation comes down, that will be “cutting the federal funds rate” next year, in line with this to keep the monetary policy stance appropriate.”
for dr Mills, the Kentucky veterinarian, this could be good news as semi-retirement is so much closer.
“I’d love to work at the zoo again,” she said, explaining that she worked with big cats early in her career and would like to do so again once she’s sold her all-cat practice. “That’s something for retirement.”