Pandemic effects and government aid are blunting impact of higher rates, for now
5 min
The world’s central banks raced at an extraordinary pace over the past year to cool inflation, but it hasn’t proved enough—yet.
Economic growth remains mostly solid and price pressures strong across affluent countries despite sharply higher interest rates.
Why haven’t growth and inflation slowed more? Much of the explanation lies in the pandemic’s weird effects and the time it takes for central-bank rate increases to curb economic activity. Additionally, historically tight labor markets have fuelled wage gains and consumer spending.
First, the unusual nature of the pandemic-induced 2020 recession and the ensuing recovery blunted the normal impacts of rate hikes. In 2020 and 2021, the U.S. and other governments provided trillions of dollars in financial assistance to households that were also saving money as the pandemic interrupted normal spending patterns. Meanwhile, central banks’ rock-bottom interest rates allowed companies and consumers to lock in low borrowing costs.
Households and businesses continued to spend heavily in recent months. Families tapped their savings, which were replenished by solid income growth. Businesses kept hiring thanks to pandemic-related labour shortages and large profits.
“There are just a lot of embedded pandemic-era forces that are working against this tightening,” Tom Barkin, president of the Federal Reserve Bank of Richmond, told reporters last week.
Two industries traditionally sensitive to interest rates—autos and construction—offer examples.
Pandemic-related shortages of semiconductor chips limited the supply of cars for sale, leading eager buyers to pay higher prices for the vehicles available. Although U.S. construction of single-family homes tumbled last year, construction employment grew over the past 12 months. Fuelling job growth were supply-chain bottlenecks that extended the time needed to finish homes and a record amount of U.S. apartment construction, which takes longer to complete.
U.S. single-family housing construction has rebounded recently thanks to historically low numbers of homes for sale. Many households refinanced during the pandemic and locked in low mortgage rates—a good reason to stay put. “I didn’t fully anticipate how much the move in interest rates would convince people not to put their houses on the market,” Barkin said.
Normally, the Federal Reserve’s rate increases force heavily indebted consumers and businesses to rein in spending because they have to pay more to service their loans. But consumers haven’t overextended themselves with debt over the past two years; household debt service payments accounted for 9.6% of disposable personal income during the first quarter, below the lowest levels recorded between 1980 and the onset of the pandemic in March 2020.
“A lot of the imbalances you might anticipate at this point in the cycle just have not had the time to build up,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.
Second, government spending has continued to bolster growth, cushioning economic shocks that proved less catastrophic than expected. While Europe’s energy crisis helped to tip the region into a shallow recession over the winter, the region skirted the deep downturn that some analysts had forecast. European governments pledged up to $850 billion to support spending.
This year falling oil and natural-gas prices have pumped up economic growth by putting money into consumers’ pockets, boosting confidence and easing pressures on government budgets. The price of a barrel of oil has fallen by nearly half in the past year, from around $120 to less than $70—below its level before Russia’s 2022 invasion of Ukraine sent prices soaring.
The reopening of China’s economy supported activity in the country’s many trading partners, while weak domestic growth prompted Beijing this month to provide new stimulus.
In the U.S., fiscal policy has provided more oomph for the economy this year. Federal funding continues to flow from President Biden’s roughly $1 trillion infrastructure package approved in 2021 and two pieces of legislation signed last year that provide hundreds of billions of dollars to boost renewable-energy production and semiconductor manufacturing.
Third, it takes time for higher interest rates to ripple through the economy and cool growth and inflation. The Bank of England first raised interest rates from near zero in December 2021, while the Fed and the European Central Bank lifted off in March 2022 and July 2022, respectively.
By some estimates, the first two-thirds of the Fed’s rate increases only restored rates to a level that was no longer pushing on the gas pedal, while the last third slowed the economy by pressing the brakes. The upshot is that policy has restricted growth for just eight or nine months, Atlanta Fed President Raphael Bostic wrote in an essay published last week.
Chicago Fed President Austan Goolsbee compared the potential coming impact of the Fed’s 5 percentage points in rate increases to the unseen hazards faced by Wile E. Coyote, the unlucky cartoon character. “If you raise 500 basis points in one year, is there a huge rock that’s just floating overhead…that’s going to drop on us?” he said in a recent interview.
Dario Perkins, managing director at the research firm TS Lombard, said higher rates are slowing growth in ways that aren’t obvious, such as by causing employers to cut unfilled jobs or companies to forgo expansion. “It might appear that monetary policy isn’t working when, in fact, it is,” he wrote in a recent report.
To be sure, some central banks might not have done enough to cool demand. The ECB, for example, increased its key rate to 3.5% this month, but it is still negative when adjusted for inflation—potentially a stimulative level.
Many economists still anticipate a recession over the next six to 18 months, either because of past rate increases or those to come.
Just how much higher to raise rates is hard to judge because of mixed signals about economic activity. In the U.S., hiring has been strong, but average hours worked declined in May and the number of people filing for state unemployment benefits has climbed in recent weeks to its highest levels since late 2021.
Falling energy and grocery prices helped lower U.S. inflation to 4% in May from a four-decade high last summer of around 9%, according to the Labor Department’s consumer-price index. The breadth of price increases has narrowed. In May, less than 50% of all prices in the CPI rose by more than 5%, down from 80% of the index at one point last year.
Central bankers remain anxious, however, because measures of so-called core inflation, which exclude volatile food and energy prices, have declined much less. Those readings tend to better predict future inflation.
Central banks in Norway and the U.K. announced half-point interest-rate increases last week to address persistent inflation. Central banks in Canada and Australia recently resumed rate increases after pausing, pointing to higher service-sector inflation and tight labor markets.
The Switzerland-based Bank for International Settlements, a consortium of central banks, warned in a report released Sunday that reducing inflation to many central banks’ 2% target could be harder than expected.
Easy gains from lower energy- and food-price inflation have been banked. The longer high inflation lasts, the more likely it is that people will adjust their behaviour and reinforce it, the BIS said. In that scenario, central banks might find they need to cause a sharper downturn to force inflation down to their goal.
“The ‘last mile’ may pose the biggest challenge,” the BIS said.
Copyright 2020, Dow Jones & Company, Inc. All Rights Reserved Worldwide. LEARN MORE
The Australian leather house has opened an immersive four-day pop-up in Manhattan, unveiling its Bloom Collection and redefining what a product launch can look like.
Following the successful launch of its Palais Collection, MAISON de SABRÉ has unveiled a new modular handbag system offering more than 720 styling combinations.
AI doesn’t rebel—people design, deploy and profit from it. The real danger lies in allowing tech companies to escape accountability while shaping regulations that protect their dominance.
4 min
A wave of corporate warnings and technical disclosures has flooded the media, with headlines worrying over “swarms” of rogue artificial-intelligence agents launching “unprecedented” cyberattacks, outsmarting their makers, and inching toward a terrifying autonomy. The most revealing part of this narrative isn’t what the software did. It’s who is telling the story—and why. When corporate leaders publicly insist that the systems they financed, engineered and deployed are suddenly beyond their power to contain, skepticism isn’t only healthy; it is essential.
For years, Silicon Valley has drawn scrutiny from civil society and global regulators over tangible harms such as youth mental health deterioration and systematic privacy violations. Today, industry figures seem to be trying to change that public image. Loudly blowing the whistle on their own systems—just as two of the leading companies were preparing for massive initial public offerings—lets AI executives position themselves as a new generation of leaders who have come to terms with their societal responsibilities. They seem to want us to believe that they no longer want to “move fast and break things” but will instead stand as vigilant guardians between humanity and a technological apocalypse.
There is one glaring problem: Software doesn’t rebel. A mathematical model possesses neither intent, malice nor the will to defy its creators, let alone extinguish our species. AI is a human artifact, engineered for profit.
When an agentic model in an evaluation sandbox connects to an unauthorized server or executes an exploit, it hasn’t staged a coup. It has tried to meet the human-defined objectives set out before it through a path its designers failed to constrain. It’s the digital equivalent of the King Midas myth, in which the king’s ill-defined wish turns even his food and drink into gold.
That powerful experimental models were able to discover novel vulnerabilities and breach external systems isn’t a sign of a dangerous superintelligence but of human error or negligence. There is no sentient actor lurking in the weights to be reasoned with, feared or pacified. There are only human software engineers, product managers and corporate boards deciding which guardrails are worth the latency cost and which permissions can be skipped in the race to market.
Policymakers and voters need to resist AI exceptionalism. In any other discipline—from civil engineering to pharmaceuticals—courts and regulators treat a system failure as evidence of bad product design and inadequate safety testing. If an aircraft crashes, we focus on finding the engineering defect, correcting it, and enforcing established liability standards for the damage created.
By leaning on an anthropomorphic narrative, Silicon Valley attempts to repackage its specific human choices that led to experimental, powerful models behaving unexpectedly during tests as an existential peril. Elevating the issue to a cosmic scale leaves the public paralyzed and takes ordinary product accountability off the table.
In the cutthroat race for venture capital and market dominance, building guardrails slows down deployment. Grandstanding about uncontrollable power costs nothing and generates billions of dollars in free publicity, justifying stock prices, all while cultivating an aura of technological capability not only to build the frontier but also ultimately to rein it in.
Governments need to recognize regulatory capture when it stares them in the face. Tech leaders’ strategy looks transparent: Alarm Washington and Brussels into creating a regime in which only trillion-dollar incumbents with fully staffed compliance and safety departments can legally operate. By sitting at the policymakers’ tables before anyone else, these companies can help draft rules digging an impassable moat protecting them from open-source developers and upstart competitors, domestic or international. The real danger is in further concentrating the tech industry into the hands of only a few companies with deep pockets.
Beijing and Washington have brushed off those tech leaders’ calls, albeit for very different reasons. Chinese state media dismissed them as part of the “Cold War playbook” and intended to preserve U.S. dominance. Xi Jinping argued for exactly the opposite at the Brics Summit on Sept. 12, calling on Brics countries to “strengthen cooperation in the field of AI, encourage open source, openness, collaboration and sharing, and break new grounds and scale new heights.” President Trump, steeped in a doctrine of unfettered capitalism and technological supremacy, called fears that AI could destroy humanity a “hoax.” Vice President JD Vance warned that AI companies “begging the government to regulate them” looked like a “Trojan Horse.”
Striving to pursue its “European way” on AI and assert regulatory leadership, Europe, by contrast, welcomed the call. European Union President Ursula von der Leyen made this clear at the State of the EU speech last Wednesday and announced that the EU will invite “the main frontier labs for a discussion on how we can support ongoing industry efforts to pace the frontier.”
Europe has been here before. In an effort to lead global regulation and react to fears borne from ChatGPT, Europe rushed its landmark AI Act into law in 2024. Already the world’s most restrictive rulebook, the framework quickly proved too broad and complex to enforce. Stalled by implementation delays and concerns about European competitiveness, the EU postponed the law’s full rollout, leaving regulations uncertain.
AI should be regulated—risks exist and should be taken seriously. But governments need to act based on available evidence and verified facts, not corporate PR panic, the views of industry insiders, or the desire for quick political wins. The greatest danger facing society isn’t that software will awaken and overthrow its human masters. It is that we will allow the creators of the software to abdicate human responsibility for the systems they choose to build and help them pull up the ladder to market access behind them.
