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--:-- Noel King: Welcome to Today Explained. I'm your host, Noel King. Over the last 14 months, on nine separate occasions, Jerome Powell's Federal Reserve has ticked interest rates up, up, up. And then yesterday, a typically subdued Powell did it again. Today, the FOMC raised its policy interest rate by a quarter percentage point. Since early last year, we've raised interest rates by a total of five percentage points. Many words to say the Fed is making money more expensive. Your mortgage, your small business loan, it just costs more to borrow. A point that he typically amped Senator Elizabeth Warren has made.
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--:-- Noel King: Chair Powell hasn't just raised interest rates. He has raised them on a curve unlike anything we've seen. It's deepest in 40 years. Deepest in 40 years. In 14 months, he's gone up five points here. And that's when things start to break.
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--:-- Noel King: Today on Explained, are higher interest rates starting to break things? Support for this show comes from ServiceNow. AI is only as powerful as the platform it's built into, don't you know? That's why it's no surprise that more than 85% of the Fortune 500 use the ServiceNow AI platform. Didn't know that. While other platforms duct tape tools together, ServiceNow seamlessly unifies people, data, workflows, and AI, connecting every corner of your business. And with AI agents working together autonomously, anyone in any department can focus on the work that matters most. I've never met an AI agent. Learn how ServiceNow puts AI to work for people at servicenow.com.
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--:-- Noel King: Support for this show comes from strawberry.me. Be honest. Are you happy with your job? Or are you stuck in one you've outgrown? Or never wanted in the first place? Sure, you can probably list the reasons for staying. But are they actually just excuses for not leaving? Let a career coach from strawberry.me help you get unstuck. Discover the benefits of having a dedicated career coach in your corner. Go to strawberry.me slash unstuck to claim a special offer.
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--:-- Noel King: This is Today Explained. Talmon Joseph Smith, economics reporter at the New York Times and good friend of Today explained. Start by telling me whether a 5.25 interest rate, which is where we're at today, is considered high.
--:-- Talmon Joseph Smith: Yes and no. So to get to the yes first, it is absolutely a very high interest rate compared to, say, the 2010s, when most of the decade, right, interest rates were at or near zero, with exception of a year or two here or there. And it's important to also keep in mind, however, the pace of this rate hike.
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--:-- Talmon Joseph Smith: So in February 2022, just over a year ago, the Fed still had baseline interest rates near zero. By summer, they were around 1%. In basically a year, they've hiked interest rates 10 times and essentially quadrupled that 1% rate from a year ago. In fact, a little bit more than that. However, in the grand scheme of things, interest rates across much of the 20th century and much of the early part of this century were at current levels or much higher.
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--:-- Noel King: Let's talk about the response to yesterday's rate hike. 5.25, you're putting it in context and you're saying, look, in context, it's not that high, but it's high for now. What's the response?
--:-- Talmon Joseph Smith: There's this sort of battle that's been going on really since 2021, the spring of 2021, when inflation first reared its head. There's been the doves, and the hawks. Doves are generally folks that say the cost of borrowing could be lower in order to support the economy and labor market in various ways. Rate increases make it more likely that companies will fire people and slash hours to shrink wage costs. Rate increases also make it more expensive for families to do things like borrow money for a house.
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--:-- Talmon Joseph Smith: On the other side, you have hawks who believe that wherever the Fed's stance is at a given time, the Fed's probably not doing enough. We have more work to do on inflation. Inflation, although we've had some welcome news, is still too high. And we need to do what we can with our monetary policy tools to bring it down.
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--:-- Noel King: For much of 2021, the doves had somewhat of an upper hand as people looked at supply chains being messed up. They look at the fact that China was still shut down even as we reopened with our vaccines. And they said much of this might be transitory, which is a fancy word for temporary. That we wouldn't have to live with these higher rates of price increases for very long. And so why not just practice patience and let this thing sort of resolve itself?
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--:-- Talmon Joseph Smith: And the Hawks were saying, no, no, no, you don't understand. We have spent trillions and trillions of dollars. Those trillions and trillions of dollars in spending have not even fully hit the economy. For now, as long as we have constrained supply, those trillions of dollars are going to stimulate demand in a way that will be unsustainable on a longer basis than you think.
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--:-- Noel King: Now, nobody could have predicted, unless they had a crystal ball, the Ukraine war. But just as there was hope that inflation might settle on its own, the Ukraine war happens, supply chains get even more discombobulated, energy prices, commodity prices, experience all sorts of volatility. And we get the sort of near double-digit inflation that we got last spring, last summer. And so the hawks ended up having the upper hand.
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--:-- Talmon Joseph Smith: As inflation has moderated over the past year, going from that peak of 9 percent down to 5 percent, and actually 4.2 percent according to the Fed's preferred measure, Doves, once again, are sort of having the upper hand. In fact, there's some hawks who have converted to dovedom saying that, OK, we were right in 2021 and in early 22. But geez, I mean, we've hiked 10 times now. We've more than quadrupled the rate. How about we take a pause?
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--:-- Noel King: Now, the Federal Reserve seems to be leaning towards taking a pause by their next meeting in June. There's this idea that this might be the last rate hike. A decision on a pause was not made today. You will have noticed that in the statement from March, we had a sentence that said the committee anticipates that some additional policy firming may be appropriate. That sentence is not in the statement anymore. We took that out. That's a meaningful change that we no longer saying.
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--:-- Noel King: Part of the reason that they're thinking about taking a pause, presumably, is because of what higher interest rates do to the economy more broadly. Let's talk about what higher interest rates have been doing. And let's start with a place where I think almost every single one of us probably focuses our attention at one point or another, which is the housing market. What do higher interest rates mean for people buying houses and people selling houses?
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--:-- Talmon Joseph Smith: In the most direct way, it makes your monthly mortgage payment much more expensive when the mortgage rate goes up. And we saw during the height of the housing boom in 2020, 2021, and even leaking a little bit into early 2022, there were plenty of folks, all of whom were able to get interest rates at 4%, 3%, and in some cases, nearly 2%. That allowed many people to lock in cheap fixed-term debt, even as interest rates have risen over the past year or so. They've been locked in, and so they've not been affected.
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--:-- Talmon Joseph Smith: However, if you're a new home buyer, you not only have to contend with higher prices that have come as a result of the housing boom that we've seen, but now you can't really get a mortgage for 2% or 3% or 4%, and in some cases, not even 5%. Often you're looking at 7%. And if your credit score is not that great, 8%. And that's if you can even afford the down payment in the first place.
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--:-- Noel King: What do high interest rates do to businesses? So this is one of the main channels that the Fed operates its policy. It is the simple mechanism that when the baseline interest rates for the cost of borrowing money goes up, every single business has their cost of borrowing set against that. And it's usually going to be a little bit higher based on your credit worthiness. That has changed.
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--:-- Talmon Joseph Smith: Now, many businesses are going to, over the course of this year, and certainly over the course of next year, going to have to go back to the well and ask for more funding to get another credit line from the bank, or just at least refresh it. Many people may have sticker shock when they realize that the new cost of borrowing money, just because the federal funds rate, that policy rate that we've been talking about, just because it's gone up by so much, their borrowing costs will have gone up by a lot as well.
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--:-- Noel King: And that could lead to some of the things that you've talked about with other guests and that you've talked about with me, which is they may make pretty drastic cutbacks internally, including stopping new expansions of business, maybe not investing in new equipment, maybe not doing new hires. And in many cases or some cases, deciding to fire people to cut back on staffing. And that's where you get into the sort of things that people really worry about, which is the eventual impact that this could have on the labor market.
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--:-- Noel King: Okay. So we have housing, we have businesses. And then, Tal, a thing that we keep hearing is that one of the reasons we have seen bank failures over the past couple of weeks is because of interest rates going up. Can you explain that? Can you make two and two equal four here. How does Silicon Valley Bank end up closing just because Jerome Powell is like, we're going to jack up interest rates a bit more?
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--:-- Talmon Joseph Smith: They had these assets on their books, these treasury bonds on their books that paid out a lot less than newer bonds issued at higher rates could, which makes those old bonds less valuable. Now, that's not usually a big problem if you don't have depositors that are worried about their money. But as news about how a lot of these assets they had in their books were not as valuable now compared to 2020 and say 2021 got out, their depositors were so concentrated. They're part of a sort of Californian elite that often also had deposits that were above the government protected limits in terms of deposit insurance.
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--:-- Noel King: When do things start to break? It's funny. You do all sorts of reporting that I do. And, you know, you're talking to, you know, asset managers that control trillions of dollars. You know, I spoke with a CIO of fixed income at BlackRock yesterday. I could just smell how rich he was with the phone. You know, you listened to Jerome Powell yesterday, and, you know, he is arguably one of the most powerful figures in the entire globe. And they all keep saying the word uncertainty, uncertainty.
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--:-- Noel King: You can just imagine, you know, as a reporter and as a citizen, I think it's very understandable that people are uncomfortable and fearful. Because when sort of the smartest money in the room and most powerful people in the world are saying that they're not sure what's going to happen either in the coming months, that's a good reason to be cautious if not fearful.
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--:-- Noel King: In terms of how we'll go from here, there's this old phrase that monetary policy operates with long and variable lags. Basically, that you never really know exactly what interest rate hikes, especially when they happen this quickly, will do to the economy, besides the obvious things that it will do to interest rate sensitive sectors. And they happen with a lag regardless. So we're not out of the woods yet.
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--:-- Noel King: I can't tell if you're optimistic or pessimistic, Tal. It depends on the day. It depends on the day.
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--:-- Noel King: All right, we're going to take a break. And when we come back, we going to talk about the last time interest rates were really really really high. Tal, you coming back with us?
--:-- Talmon Joseph Smith: Yep.
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--:-- Noel King: Support for Today Explained comes from Built Rewards. These days, it seems like everybody has a rewards program. You swipe your card and you get one cent on the hundred dollars. But with your rent, frequently you just pay month after month. You never get anything from it other than that roof over your head. Not anymore, says Built Rewards. Built Rewards says it lets you earn points on your rent. By paying rent through Built, they say you can earn flexible points that can be redeemed toward hundreds of hotels and airlines, perhaps a future rent payment, your next Lyft ride, and so much more.
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--:-- Noel King: That's J-O-I-N-B-I-L-T dot com slash explained. Support for this show comes from Macy's. It's almost fall, and that means it's time to cycle your wardrobe to the cold setting. Because while everyone loves a breezy summer outfit, let's be real, layering is even more fun. That's why Macy's Fall Fashion Guide has everything you need to piece together the perfect look for you. It's your one-stop shop for fall's latest trends and must-haves, curated by their experts.
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--:-- Noel King: Tom and Joseph Smith of The New York Times, the federal funds rate, the interest rate is now at 5.25 percent, which seems very high to us. But historically, it is not that bad at all. I was looking at some data the other day. In 1980, it was 20 percent. What was it like to be a consumer during that period?
--:-- Talmon Joseph Smith: In the early 80s, the average boomer, who is now somewhere between 60 and 80 years old, they were in their late 20s and in their 30s like most millennials are now. So interest rates were really high, and that's in part because inflation was really high, and the Federal Reserve of that era was doing its own version of hiking the cost of capital in order to try to bring inflation down.
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--:-- Robin: There are those who claim Paul Volcker is the real father of this recession. In October, soon after he became Federal Reserve chairman, the Fed intensified its efforts to stop inflation. Its basic strategy was to cut back the amount of money that would be available for borrowing. They succeeded eventually, and you got a really nasty recession out of it.
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--:-- Paul Volcker: No, I'll claim no paternity. I don't even like the question being asked that way. But in the meantime, and even for a bit afterwards, interest rates were really high. And I was talking with your heroic producer before we started chatting, and he mentioned how Rocky Balboa in one of the Rocky movies is like bragging about how he got a mortgage rate that was 9.5% or something along those lines.
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--:-- Paul Volcker: This is Miles, the producer. It wasn't Rocky. It was his wife, Adrienne. And she wasn't bragging so much as just stating the fact. I regret the error. The band said it will give us a $16,000 first mortgage at 9.5%. Well, hey, I don't matter. I said we'd get the house now, huh? Yeah, but we didn't go upstairs. I don't matter. It's just details. I'm sure it's nice. And so I think that bit of pop culture is sort of telling about the sort of relative scale of what it was like to sort of operate as a consumer and as a person during that time.
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--:-- Paul Volcker: And I think in some ways it serves as a cautionary tale as we debate as a country when and if we should pause our current rate hiking cycle. I was talking to my mom the other day, and she was telling me that when my parents bought their house, their interest rate was 12%. It is inconceivable to me of the 3% interest rate that people might have been borrowing money on those terms.
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--:-- Paul Volcker: When did the interest rates start to come down? They came down from their high teens in the early part of the 80s, down, down, down through the 90s. And then comes the Great Recession. And you have the Fed's policy interest rate go all the way down to zero. The Federal Reserve has decided to keep interest rates at a record low. With the economy continuing to bleed jobs and credit still hard to come by, the central bank said it will employ a new tool hoping to boost the economy out of the recession.
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--:-- Paul Volcker: There was talk about whether the entire global financial system would collapse. We actually had deflation for a period of time that lasted for quite some time depending on the sector. I'm sure there's plenty of people that remember housing prices dropping by double digits continually for a period of time. And job loss, permanent job loss especially, was very prominent. And it was a period of folks having their car taken by the repo man, having their houses foreclosed on.
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--:-- Paul Volcker: In a way that was incredibly widespread and common, it seemed like everybody knew somebody that was affected if they weren't affected themselves. And in terms of the overall economy, what economists call aggregate demand was very, very suppressed. There's a much more simple way to put it, which is if you're broke, you can't spend that much. And a lot of people were broke.
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--:-- Paul Volcker: I'm sure you and I both vividly remember when the Obama administration had a big stimulus plan. The American Recovery and Reinvestment Act that I will sign today a plan that meets the principles I laid out in January is the most sweeping economic recovery package in our history. And it worked, but it didn't really get us out of a rut. But people were still very, very upset about that stimulus plan, and they thought it was irresponsible in some cases.
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--:-- Paul Volcker: It began last February with an offhand slap at President Obama's stimulus plan by a cable commentator. We're thinking of having a Chicago Tea Party in July. All you capitalists that want to show up to Lake Michigan, I'm going to start organizing. So that sort of ended up leaving the Federal Reserve as the only game in town. And the Federal Reserve can't spend in the direct way that the government can, but it can lend.
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--:-- Paul Volcker: And so the 400 PhDs at the Federal Reserve and the Federal Open Market Committee, all the folks that run the Fed together, circle around this idea of like, okay, well, what if we just keep it really inexpensive for businesses to finance our operations? Hopefully that'll do something.
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--:-- Paul Volcker: So I'm not sure about the age range of our listeners here, but I'm sure plenty of people have seen the meme of like a stick man poking a blob saying, do something. And for much of the 2010s, that's what the Fed was doing. And they weren't getting a lot of results by some measures besides helping finance fledgling industries like tech, which ended up being a very big deal.
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--:-- Paul Volcker: And, you know, there's an uncertain but real share of, you know, apps that we have and delivery services and all sorts of things of that nature that we might not have if the cost of borrowing was harder for startups. Give me a few examples of the companies that you're talking about. Your Ubers of the world, Netflix, the sort of big tech companies that we've seen.
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--:-- Paul Volcker: Why would you go after revenue? Because to make money? No. If you show revenue, people will ask how much and it will never be enough. The company that was the 100Xer, the 1,000Xer becomes the 2X dog. But if you have no revenue, you can say you're pre-revenue. You're a potential pure play. It's not about how much you earn. It's about what you're worth. And who's worth the most? Companies that lose money.
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--:-- Paul Volcker: A lot of that, some think, would not be as powerful of an industry in our economy. The sort of tech-based engine would not be as strong without this period. However, the apps that we scroll or the delivery services that we have, you know, don't necessarily raise living standards. And I guess that brings me very quickly to just the counter argument here that, no, in the end, those low interest rates actually did help stimulate things.
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--:-- Paul Volcker: By the end of the slow jobs recovery that we got throughout the Obama era, the economy kept expanding because it was cheap for businesses to borrow and inflation was still low. And so we all chugged along and people were feeling pretty good about the economy, even though there was still an affordability crisis at that time. And even though obviously politically the country was incredibly divided. And then, of course, we had COVID, which has been an incredible exogenous shock that has sort of changed everything, at least for now.
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--:-- Paul Volcker: So at the end of the day, Tal, what's more abnormal? The moment we're in where we see interest rates ticking up and we're all getting very nervous or all of those years where interest rates were near zero. What kind of world do you think we're headed into? The one that we came out of or the one that we're in in early 2023, mid-2023?
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--:-- Talmon Joseph Smith: So I'll go back to that phrase I used before, at risk of being repetitive, uncertainty. There's a wide band of uncertainty. There's a lot of very credentialed, very proven, smart people who respectfully disagree on this issue. But in terms of my own inkling, I think we'll probably end up somewhere in between.
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--:-- Talmon Joseph Smith: It seems inevitable to me and to many of other reporters that the Fed will eventually have to ease from their current rate position. For example, a guy that I know at JP Morgan that's very high up there and well-respected, he, as well as another investment firm called Bespoke, both think that inflation could be below 3% by early next year.
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--:-- Talmon Joseph Smith: And that even if we have a nasty temporary uptick in inflation in the next month or two, that the overall yearly rate could still be below four by sometime in summer. At which point people might say, well, Fed, it looks like you're actually sort of winning your fight on inflation, especially since a lot of the data that we get on inflation lags behind us.
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--:-- Talmon Joseph Smith: Often we're talking about data that is a month or more behind the present. And so that would put a lot of pressure on the Fed to cut rates because if the point of a 5.25% interest rate is to get inflation down and inflation is now seemingly coming down, heading back towards 2-ish percent, then maybe it could be time to ease.
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--:-- Talmon Joseph Smith: Especially if the tradeoff could be what some might say is unnecessary pain on small businesses and those employed by small businesses as well as large businesses. But the flip side of that is that the country does really seem to be scarred by recent inflation, right? And I think there'll be a hesitation to cut rates too much.
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--:-- Talmon Joseph Smith: Certainly, I don't think there's a big coalition for going back to 0% or near 0% anytime soon. You know, the funny thing here is that, you know, there were clearly some excesses that did come from having a near zero rate, right? The animal spirits kind of got crazy. There was a lot of froth, right? I'm sure we all remember, you know, reading about, you know, scooter companies valued at billions of dollars based on no proven track record, right? Things got a little bit crazy.
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--:-- Talmon Joseph Smith: And so it does seem like there'll be somewhat of a hangover that makes it so that we end up somewhere in the middle ground.
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--:-- Noel King: Talman Joseph Smith covers economics. You can find more of his work at a little newspaper called The New York Times. Miles Bryan and Amanda Llewellyn produced today's show. Matthew Collette edited. Russ Hanneman advised. Michael Raphael and Paul Robert Mounsey engineered. I'm Noelle King. It's Today Explained. Thank you.
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