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Why is the U.S. economy still running hot after 17 rate hikes?

Fed Chair Jerome Powell recently stated that the economy was running hot and that cutting interest rates was not a possibility. He argued that despite the considerable decline in inflation since rates were hiked, inflation remains sticky and from above the reaching target of 2%. We can then ask ourselves, why? Why is the economy still running hot after 17 rate hikes to tame inflation?

The answer is right under our nose but we failed to see it. Long-term high-interest rates are a financial boon for the wealthy. Investor, CEO, and Co-Founder of Ritholtz Wealth Management Josh Brown, explained that wealthy people love high interest rates because they earn stock-light returns on their cash without having to take any risk. In other words, they earn more cash on their cash than they could possibly spend. He argued that 5% interest rates are a stimulus check for the top 10 percent of households by net worth.

What we are witnessing is a reverted Cantillon Effect. The Cantillon Effect is the idea that the injection of new money into the economy creates an uneven redistribution of wealth through inflation whereby the rich get richer as the injection of new money inflates asset prices, and the poor get poorer as the price of goods and services increases, which makes it expensive for consumers as their purchasing power decreases. The reverted Cantillon Effect is when the central bank attempts to take as much cash out of the economy by applying monetary tightening policies such as increasing interest rates and selling bonds back into financial markets.

Higher interest rates increase interest on cash. It means that when interest rates are higher, banks may increase yields to attract more deposits, which can benefit savers. Although most wealthy people's wealth is tied to their investments (stocks, bonds, real estate, ownership in private businesses), they still sit on a pile of cash in case monetary tightening is applied as is the case today.

Cash is an asset that appreciates in value when higher interest rates offer lenders a higher return. When the Fed raises interest rates, the U.S. dollar often strengthens due to increased demand for dollar-denominated assets that now offer higher returns. Thus, as the wealthy retain more cash than the working class, they are getting richer even under high-interest rates, which was supposed to reduce the amount of money in circulation in the economy. This is why, after 17 rate hikes, and interest rates still above 5%, the inflation remains sticky and the economy still runs hot.


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