In a significant development for the financial world, the Federal Reserve has officially halted its interest rate hikes, maintaining rates at the current range of five to five and a quarter percent. This decision comes after a series of ten consecutive increases.
The unexpected pause by the Federal Reserve raises questions about the future trajectory of the economy, catching the markets off guard and leaving them ill-prepared for what lies ahead. The implications of this decision can be understood by examining three key steps.
Reflecting on Previous Cycles
To gain insight into the potential outcomes, let's examine historical instances. In the early 2000s, the Federal Reserve paused interest rate hikes, similar to the current situation.
Following this pause, interest rates declined, leading to the dot-com bust. It is worth noting that when announcing the pause, Jerome Powell, the Federal Reserve Chair, emphasized that it did not indicate a future recession.
However, historical patterns suggest that the subsequent interest rate movements often contradict expectations.
Depression-like Economic Indicators
Several indicators point to an economic environment reminiscent of an economic depression.
The unemployment rate is at a historic low, yet there are alarming signs such as an inverted yield curve and declining home prices.
Commercial real estate faces significant challenges, and banking failures are rising.
These factors, coupled with the impact of supply chain disruptions and reduced stimulus measures, have contributed to a decrease in the Consumer Price Index (CPI) from 9% to 4%.
However, despite these indicators, the Federal Reserve has pursued an aggressive rate-hiking policy, exacerbating the economic downturn.
Interest Rate Paradox
The future trajectory of interest rates presents a paradoxical situation. While conventional wisdom suggests that lowering interest rates would stimulate economic activity, the current environment challenges this notion.
Milton Friedman's interest rate fallacy posits that low-interest rates do not necessarily imply loose monetary conditions.
In fact, during times of crisis or economic depression, obtaining loans becomes increasingly difficult, especially for small businesses and entrepreneurs.
This discrepancy creates a scenario where money appears cheap but is tight in practice, hindering the creation of goods and services.
Considering the aforementioned factors, it becomes clear that the pause in interest rate hikes may lead to further deterioration of the real economy as entrepreneurs struggle to secure the necessary capital.
This will produce fewer goods and services, exacerbating the ongoing economic depression.
The financial economy, driven by asset prices, takes precedence over the real economy, which should be the true driver of wealth.
As we move into 2024, it is crucial to recognize the potential consequences of this interest rate pause.
The natural state of the economy, characterized by deflation and depression, is likely to worsen without effective measures to address the challenges faced by entrepreneurs and the real economy.