As the Federal Reserve raised interest rates to the highest level since 2001, borrowing got more expensive. What’s that really mean for consumers and businesses — and are we in for a recession? Local economists weighed some factors.
John Burger, professor of economics at Loyola University’s Sellinger School of Business, said consumer credit card spending may not change all that much. “Credit card interest rates are already so high, and they don’t move very much through federal policy,” he explained. “More likely, where this will matter for consumers is when they’re buying a car or buying a house.”
But there’s one type of household hit extra hard by rising interest rates: the low-income one, pointed out Alessandro Rebucci, associate professor of economics at the Johns Hopkins Carey Business School. “Low-income households, unfortunately, often cannot repay all their credit card balances within the grace period,” he said. “This is where higher rates hit households the hardest. The cost of credit card borrowing goes up much more than in proportion to the increase in monetary policy rate.”
Rebucci noted that households often buy furniture on installment and, in recent years, vacations, weddings and other life experiences. “Another sore point for middle-income households is student loans that have pretty high rates even in good borrowing times,” he added.
So far, consumer spending has not taken a dive. “The amazing thing is that consumption has remained as elevated as it has given these headwinds,” said Dr Anirban Basu, chairman and CEO of Sage Policy Group. “But if the labor market softens materially, which I still anticipate, household expenditures will suffer, perhaps even later this year.”
Higher interest rates are significant for businesses who are borrowing in order to expand. “Let’s say a business is considering whether to buy new machines,” Burger said. “Some businesses will go ahead and some will put it off.”
Rebucci agreed: “Waiting to purchase capital goods for investment purposes is a typical response to higher borrowing costs,” he noted. “However, working capital needs to be financed just to operate normally, and that cannot be deferred.”
Firms may cut nonessential costs, postpone hiring new employees, and, if their demand declines, they may also fire workers. “If they have saved some liquidity as a precautionary buffer, they might draw those down to complete essential projects or acquire necessary equipment,” said Rebucci.
Higher interest rates can certainly dampen business investment, noted Basu. “This is most likely in capital intensive industries like energy extraction,” he said. “Indeed, equipment purchases declined in real terms during two of the last three quarters.”
Higher borrowing costs undoubtedly played a role, he added. “This helps explain some of the turbulence we’ve observed among larger technology companies,” said Basu.
What about the risk of recession? That’s heightened when spending slows down too abruptly, Burger explained. “What started this? We had inflation,” he said. “The fed is effectively popping the brake a little bit on the economy — they want it to slow down, not stop.”
That’s where the term “soft landing” comes from. “What that refers to is, it’s very hard for the fed to get this just right,” Burger said. “Historically, they rarely pull it off.”
Basu believes there remains a risk of a hard landing, in part because the Federal Reserve waited so long before addressing inflation. “Given the lag effects of prior Fed rate increases, tightening credit conditions in the aftermath of several prominent bank failures, consumer indebtedness, distress in a number of key commercial real estate segments, student loan repayments, and a potential UAW strike in September, risks remain despite the fact that growing numbers of economists have reversed their recession calls,” he said.