Email of the day on inflation and interest rates hikes
Comment of the Day

January 30 2023

Commentary by Eoin Treacy

Email of the day on inflation and interest rates hikes

In a recent article, Joseph Stiglitz argues that the current inflation is primarily due to the supply-side shock of the Covid crisis and to shifts in the demand patterns. His view is that the rate of inflation has already peaked - it is 1% higher now than in June 2022. He claims that the rise in interest rates has been largely passed on to consumers via higher prices and that any future interest rate rises would be inflationary.

Eoin Treacy's view

Thank you for this email which may be of interest. I believe the article you referring to is Stiglitz’s one in Project Syndicate. Here is a section:

Worse, it is not even clear that there is any upside to this approach. In fact, raising interest rates could do more harm than good, by making it more expensive for firms to invest in solutions to the current supply constraints. The US Federal Reserve’s monetary-policy tightening has already curtailed housing construction, even though more supply is precisely what is needed to bring down one of the biggest sources of inflation: housing costs.

Moreover, many price-setters in the housing market may now pass the higher costs of doing business on to renters. And in retail and other markets more broadly, higher interest rates can actually induce price increases as the higher interest rates induce businesses to write down the future value of lost customers relative to the benefits today of higher prices.

To be sure, a deep recession would tame inflation. But why would we invite that? Fed Chair Jerome Powell and his colleagues seem to relish cheering against the economy. Meanwhile, their friends in commercial banking are making out like bandits now that the Fed is paying 4.4% interest on more than $3 trillion of bank reserve balances – yielding a tidy return of more than $130 billion per year.

The assumption the passthrough mechanism from costs to rents is seamless is a big leap. Without a healthy economy that delivers wage growth, rental yields increase through lower purchase prices. This article describing how robo-purchases by institutional investors in property have gone wrong, particularly Opendoor, may also be of interest. 

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