What impact will rising interest rates have on the economy in 2023? This is one of the big economic questions of the moment, and it is answered by Blu Putnam, chief economist at CME Group.
In a video released by the financial markets firm, Putnam explains how the Federal Reserve's monetary policy affects household finances as well as the most immediate consequences of its current rate hike policy.
Monetary and fiscal policies
Two aspects of economic policy have created the current high inflation situation: the Federal Reserve's policy of historically very low rates, maintained for years, and the increase in government spending over the last two Administrations, and especially during the current Biden Administration.
Economists generally believe that an increase in domestic demand will increase inflation, so in order to reduce inflation, domestic demand must be reduced. There are two instruments that do this: monetary and fiscal policy. The Federal Reserve, in charge of monetary policy, is raising interest rates and helping to control inflation. However, Joe Biden responds by adding more government spending measures, which is like trying to put out a fire by drowning it in gasoline. In fact, despite the Fed's policy, inflation is holding out against falling. The year-to-year rate surprised analysts by dropping only one tenth of a percentage point in September to 8.2%.
Real effects in 2023
That is not to say that monetary policy is not having an effect. Which are they? Blu Putnam explains that the "Federal Reserve’s primary tool for influencing the real economy runs through its ability to set short term interest rates." He reminds us that the Fed has been raising interest rates and reducing its balance sheet. He adds:
As for the US real economy, rate hikes have a direct effect on mortgages. 30-year mortgage rates have more than doubled in 2022. This has made buying a house much more expensive. House already under construction are generally completed, but builders typically become more cautious about new projects. Future housing construction is likely to be constrained in 2023. This lagged impact eventually spreads through all the inputs in the construction process, from labor in wood to appliances, and so forth.
In short, "the rate hikes of 2022 have been felt in mortgage rates, but the full impact on the economy, which has already been set in motion, will not be observed until 2023."
On the other hand, the CME Group economist recalls that housing prices are not part of the price index. Currently, Putnam says, core inflation may appear to be difficult to reduce. However, he points out that the forces for its control are already in place.