Why High Interest Rates Haven’t Broken the Global Economy — Yet

For over a year, central banks globally have been aggressively hiking interest rates to combat inflation. Conventional wisdom suggested such tightening would inevitably lead to a severe recession or even a global economic meltdown. Yet, surprisingly, the world economy has proven remarkably resilient. Why haven’t high interest rates caused the predicted collapse?

Strong Labor Markets and Consumer Resilience

One primary factor is the robust state of labor markets in many major economies, particularly the U.S. Low unemployment rates have sustained wage growth and consumer spending, which forms the backbone of economic activity. People with jobs continue to spend, albeit more cautiously, providing a crucial buffer against economic contraction.

Corporate Adaptability and Strong Balance Sheets

Many corporations entered this period with relatively healthy balance sheets, having benefited from strong profits in previous years. While borrowing costs have risen, many larger firms had refinanced debt at lower rates during the pandemic, delaying the full impact of higher rates on their financing costs. Innovation and cost-cutting measures have also helped maintain profitability.

Government Spending and Fiscal Support

In various regions, government spending, whether for infrastructure, green initiatives, or social programs, has continued to provide a degree of fiscal stimulus, counteracting some of the monetary tightening. This has created demand and supported specific sectors.

Delayed Impact of Monetary Policy

Monetary policy operates with a lag. It can take 12-18 months, or even longer, for the full effects of rate hikes to permeate through the economy. We might still be observing the initial impacts, with the more significant consequences yet to manifest. Businesses and households take time to adjust to new borrowing environments.

“Sticky” Inflation and Real vs. Nominal Rates

While headline inflation has come down, core inflation remains “sticky” in some areas. This means that, in real terms (adjusting for inflation), the interest rates might not feel as high as their nominal values suggest to borrowers, especially if their incomes are also rising.

The “Yet” Factor: Lingering Risks

Despite current resilience, the dangers are far from over. Prolonged high rates could eventually strain household budgets as mortgage rates reset and credit card debt becomes more onerous. Small and medium-sized enterprises (SMEs) are often more vulnerable to rising borrowing costs. A credit crunch could still emerge, particularly in sectors heavily reliant on financing or in commercial real estate. Geopolitical tensions and energy price volatility also remain significant wildcards.

Conclusion

The global economy has defied many predictions, showcasing remarkable strength in the face of aggressive monetary tightening. A combination of robust labor markets, corporate resilience, and the inherent lags of monetary policy has provided a cushion. However, this is not a signal to declare victory. The “yet” in our title is critical. Policymakers and investors must remain vigilant, as the full implications of this historic tightening cycle may still be unfolding, with potential vulnerabilities lurking beneath the surface.

Source: Original Article