Why Higher Interest Rates Will Not Lead To Recession

It’s amazing all the panic I see when reading the news pertaining to higher interest rates.  Mortgage rates have gone up about 0.5% in the last few months, and stock markets have lately been hit by fears that the Fed will not only taper off Quantitative Easing, but will eventually raise the discount rate, which is pretty much the standard rate that many lending activities are based from.

The naysayers proclaim things like:

“Higher mortgage rates are going to kill the housing market recovery.”
“Higher interest rates will pop the housing bubble.”
“Higher lending costs will lead to recession.”

I’m sure you get the point.

Personally, I’m not buying it.

Demand fell.  Let’s look back to the reason that rates fell to the point where they did?  It was the economy.  Basically, companies and people stopped borrowing as the housing bubble popped, people were losing their jobs, and wealth was disappearing in the stock market crash.  All of that meant that credit was simply not in demand, which by the economic laws of supply and demand meant that rates had nowhere to go but down.

And they did.

But, now, they’re going back up, which is actually a good thing.  It means that there is more demand.  People want mortgages.  Companies want to borrow money.  These are not the signs of a fragile economy, but instead are indicators that the economy is indeed finding stable ground.

No permanent solution.  Low rates were never meant to be a permanent solution.  When the Fed stepped in and basically made the discount rate zero, meaning banks could borrow at no charge, this was meant to stop the free fall that the economy was in.

Now that we’re no longer in a free fall, the underlying reason for making the rates so low simply isn’t there.  Jobs may not be getting created as robustly as many would like, but we’re not shedding hundreds of thousands of them per month.  Housing prices are going up.  The actual number of homes being sold still has a ways to go in terms of recovery, but with the market showing such pent up demand, do people honestly believe that another bubble is right around the corner?

No more dirty work.  As the Fed tightens up their policies, it means that they are no longer responsible for shouldering the workload involved with our economic recovery.  Let’s think about that for a second.  With the Fed doing all the work, it’s been pretty easy for companies, including those in the financial industry, to sit back and let the Fed do all of the work.  The Fed has taken a lot of heat for getting so involved, but even if they become less involved, this shouldn’t mean that the economy will just collapse.  Instead, it means that the private sector now has to get back to hard work that they’ve been able to avoid for the last few years.

Since profits are at stake, you bet someone will do it.  Don’t believe for a single second that just because the Fed ‘backs off’ that nobody will pick up the slack.  Someone will see the opportunity to get back to business and will take charge.

This is a test.  This is only a test.  The stock market has been tested quite a bit since the Fed announced that they’ll taper things off (which leads to speculation that interest rate jumps aren’t far behind).  As I watched the stock market react day after day, I could sense that a lot of the ‘fears’ and ‘jitters’ and ‘uncertainties’ were merely posturing.

In fact, it felt to me like Wall Street was trying to needle the Fed into backing off from their plan to back off.  After all, if the stock market did a little mini-tank, wouldn’t that show that the market wasn’t ready for the Fed to back off of their control over the economy and maybe they should stick with it a while longer?

Am I saying that Wall Street was purposefully manipulating prices?  Well, it does seem to me that the activity for multiple days following the announcement should have already been priced in to a large degree.  So, if you follow the markets, draw your own speculation on that.  I’ll also say that I hope that the Fed doesn’t back down because of a few bad days.

In short, the Fed has made it clear that the days of free and easy money are coming to a close.  While this sends many people into a panic, I think it’s a great sign for our economy and indicates that even better days are ahead.

Readers, have interest rate changes spooked you or do you see it as a sign of opportunity ahead?

15 thoughts on “Why Higher Interest Rates Will Not Lead To Recession”

  1. I think that the fears and jitters are almost always posturing. I’m not sure if a rate increase is going to slow things down, but we are definitely due for one pretty soon. We can’t stay here forever.

    • I agree but you know the world will come crashing down (according to some) when it does inevitably happen. *sigh*

  2. I was spooked by the sudden rise in mortgage interest rates. My debt is in a flex rate HELOC and I was terrified the rates would jump suddenly so I have locked in at a low rate.

    People who have a lot of consumer debt will struggle to make payments if interest rates rise drastically. They will have less money to spend on new purchases or they will default and that will slow the economy.

    • Well, rates aren’t going to jump from lowest to highest…they’ll go somewhere from lowest to really low, and maybe to pretty low. The point being that the rates, even after they get raised, will likely still be very low compared historically. I would hope that people will be able to stay afloat. If not, then they’re probably living a little too close to the edge as it is.

  3. Higher interest rates translate into higher monthly payments. That in itself has to reduce demand because there are less people who can afford the hoes. Typically, lower demand means lower prices. We’ll see how it affects housing in the next year. I suspect interest rates will come down before it goes higher.

    • I’d be interested to see if that’s the case. I could see some small dips but I don’t envision a big drop that’s long lasting anytime soon.

  4. I don’t think the increase in interest rates has spooked me, but I’m not quite buying that the economy is “all better” now. I know that housing in my area has increased about 20-30% this year alone, which makes me nervous while incomes have stagnated. I don’t like to be gloom and doom, but I think we’re a few years away from a rosy economic outlook.

    • I agree, but I’ve said all along that although this recovery is achingly slow, it’s being done in a way that will hopefully provide stability moving forward, so that when the next recession hits or bubble bursts, it doesn’t bring the whole economy crashing down.

  5. higher interest rates lead to higher rates on savings as well– so for those of us who have our financial houses in order– they can actually be a great thing.

    my only concern would be about the housing market. in my area- the market is finally starting to rebound, and i don’t want people to become hesitant once again just because interest rates are starting to climb.

    • Well, interest rates on mortgages have increased at least a percentage point over the last few months and so far it doesn’t seem to have slowed anything down. Hopefully that continues.

  6. The people across the street currently have their house for sale. They are asking a very high price. People who are interested are quoting increasing mortgage rates and using that to try to get them to lower their price. I mentioned to my wife that I paid 8.5% interest on my first mortgage (before I met her). Today’s rates are still VERY low. The current interest rate movements do affect real money, but they are pimples compared to where interest rates used to be. I agree that rising interest rates will not cause a recession.

    • It’s all about perspective. If your first entry into the housing market was with rates in the 3% range, then todays rates will seem high, but if you remember the rates of days past, you’ll still realize they are low. I remember when I bought my first place in 1999, I thought it was great that I got a 30-year mortgage at 6.875% and when I was able to refinance to a 15-year mortgage at 5.25% a couple of years later, I thought I’d hit the jackpot!

  7. I’m so happy you’re willing to write about the economy. I have read too many articles on how to budget recently.

    I have to disagree with “the Fed has made it clear that the days of free and easy money are behind us.” (1) The Fed has been anything but clear and (2) they definitely have not given the impression that “easy” money is behind us.

    Just a few days ago, Bernanke said: “Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.” I believe easy money is here to stay for a LONG time. Even if the Fed begins to wind down bond purchases later this year (causing long-term interest rates to creep up), short-term rates will be zero AT LEAST until 2016. The labor market is nowhere near where it should be (their target of 6.5%).

    I also have to add that I’m not optimistic about the housing market, either. Most of the properties in Vegas (places hit hard by the recession) have been gobbled up by investors, not families. I expect prices to continue rising only to fall back down. The “bubble popping” was the correction of sky-rocket prices. They don’t need to go back up.

    • I see what you’re saying to a degree regarding the housing market, but I think there was an overcorrection and prices were too low from what they should have been. Now we might be overcorrecting the overcorrection if that makes sense 🙂

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