Does high interest rates cause recession?
The global economy runs on money, so when the cost of money in the form of interest rates rises rapidly, growth may slow sharply or even give way to a recession.
Whenever the Federal Reserve lifts rates to battle high inflation, the risk of a recession increases, and the US economy has typically fallen into an economic downturn under the weight of rising borrowing costs.
A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.
Recessions can be the result of a decline in external demand, especially in countries with strong export sectors. Adverse effects of recessions in large countries—such as Germany, Japan, and the United States—are rapidly felt by their regional trading partners, especially during globally synchronized recessions.
The financial sector generally experiences increased profitability during periods of high-interest rates. This is primarily because banks and financial institutions earn more from the spread between the interest they pay on deposits and the interest they charge on loans.
Note that the yield-curve slope becomes negative before each economic recession since the 1970s. That is, an “inversion” of the yield curve, in which short-maturity interest rates exceed long-maturity rates, is typically associated with a recession in the near future.
The Fed may wait too long to cut interest rates and spark a recession, economists say. As inflation gathered force in 2021 and 2022, the Federal Reserve notoriously waited too long to raise interest rates, allowing consumer prices to continue to climb sharply, Fed officials now acknowledge.
- Energy. Oil and gas companies stand to benefit because higher prices mean increased revenue, as the cost of the product being sold has gone up. ...
- Transportation. ...
- Financial Sector. ...
- Utility Companies. ...
- Healthcare Providers. ...
- Consumer Staples. ...
- Technology. ...
- Industrial Stocks.
Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall. Similarly, to combat the rising inflation in 2022, the Fed has been increasing rates throughout the year.
When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments. This slows down spending, typically lowering overall demand and hopefully reducing inflation.
Which is worse inflation or recession?
The cost of recessions in terms of wages and employment are more regressive. Inflation, however, is a form of income redistribution in the short run, but does not directly reduce incomes in the aggregate.
“As a result, the leading index currently does not signal recession ahead. While no longer forecasting a recession in 2024, we do expect real GDP growth to slow to near zero percent over Q2 and Q3.”
Economists predict another year of slow growth around the world in 2024. While the risk of a global recession is lower in the year ahead, two G7 economies dipped into recession at the end of 2023.
Higher interest rates typically slow down the economy since it costs more for consumers and businesses to borrow money. But while higher interest rates can make it more expensive to borrow and could hamper overall economic growth, there are also some benefits.
The Fed also issues cash, which pays no interest, so the Fed makes steady money on the difference between interest-bearing assets and the zero return of cash. But when the short-term rates the Fed pays rise sufficiently to make its interest expenses greater than its interest earnings, the Fed loses money.
The Fed has repeatedly raised rates in an effort to corral rampant inflation that has reached 40-year highs. Higher interest rates may help curb soaring prices, but they also increase the cost of borrowing for mortgages, personal loans and credit cards.
The Washington DC-based institute this week nudged its global growth outlook slightly higher to 3.2% in 2024 and projects the same rate in 2025. “When we do the risk assessment around that baseline, the chances that we would have something like a global recession is fairly minimal.
The research of the Federal Reserve Bank of New York, currently puts the probability of a U.S. recession before February 2025 at 58%, that's about as high as a forward-looking recession probability has been on this model since the 1980s.
Lasting from December 2007 to June 2009, this economic downturn was the longest since World War II. The Great Recession began in December 2007 and ended in June 2009, which makes it the longest recession since World War II. Beyond its duration, the Great Recession was notably severe in several respects.
In research released on a day when inflation data showed an unexpected spike, the authors found that over 16 episodes of "disinflation" engineered by central banks in the United States, Germany, Canada and the United Kingdom, "we find no instance in which a significant central bank-induced disinflation occurred without ...
How long will recession last?
How long do recessions last? Historically, recessions have lasted anywhere from two months to several years, according to the National Bureau of Economic Research.
The average length between the initial rate hike and the start of a bear market is 3.5 years, and it's been 4.1 years between the initial hike and the start of a recession. However, that does not mean there is no risk of volatility.
Inflation can have varying effects on different wealth brackets with the middle class benefiting from real estate assets, but facing challenges in other areas. The "wealth effect" benefits those with substantial assets from increased asset values, like stocks, real estate and entrepreneurial endeavors.
Prior research suggests that inflation hits low-income households hardest for several reasons. They spend more of their income on necessities such as food, gas and rent—categories with greater-than-average inflation rates—leaving few ways to reduce spending .
Some of the worst investments during high inflation are retail, technology, and durable goods because spending in these areas tends to drop.
