How do interest rates rise?
Cullen, I have been struggling thinking of an environment where interest rates could rise 2%-3% from where we are at right now. I was wondering how you think rates would rise when 1) we have an outsized amount of income going to those earners who would tend to save that marginal dollar instead of spending it and 2) housing (and potentially other assets) would be negatively impacted if interest rates rose which would tend to slow down the economy and bring interest rates right back down.
Thanks in advance
Well you'd have to get a whiff of inflation. Then the Fed would begin lifting their targets which would cause bond traders to front-run the Fed and starting pushing rates up. Until you get a sustained hint of inflation rates will remain low. So the question really is, will we get any inflation? My current view is that the economy will be mostly healed by the end of 2021 and that means that 2022 could be a year of some price pressures as the year over year figures will start to look modestly high coming off the COVID depressed lows.
Sorry Cullen, I think I phrased my question incorrectly. Realizing that rates are correlated to inflation, how do we get inflation with the above assumptions? I just don't know how we get any inflation when the bottom 50+% of earners are receiving such a small share of total income.
Inequality can't be the dominant driver of inflation. After all, the countries with the worst inflations are often cases of the most extreme inequality. Many African countries come to mind....
I think it's going to be a matter of how fast the recovery occurs. My guess is that the unemployment rate is going to fall much faster than many people assume. As COVID dissipates in 2021 the economy will essentially revert back to where it was pre-COVID. So you have 2.5% core inflation pre-COVID, but now you have all the stimulus AND the supply shortages and that, in my view, takes us to 3-4% inflation by 2022. Not crazy high, but high enough to get the Fed on its heels....
How does "After all, the countries with the worst inflations are often cases of the most extreme inequality." logically support "Inequality can't be the dominant driver of inflation."? It doesn't!
@john-daschbach, inequality creates an insufficient amount of demand from a large portion of the populace. If anything it should be deflationary. That would seem to be consistent with the evidence of the last 40 or so years. Hyperinflations and high inflations tend to happen for other reasons (mainly war, regime changes, unusual supply shocks, etc). While inequality can exist in a country with high inflation it is not the dominant factor creating the high inflation.