When inflation started to spike in 2022, the Federal Reserve made the only move it could: raising interest rates. Over the course of 18 months, rates shot from near zero to above 5 percent and have remained there since. Now inflation appears under control, having fallen steadily since July 2022. But while the Fed may be done raising rates, it’s not cutting them back to zero anytime soon.
According to the central bank’s most recent projections, rates will stay where they are for most of 2024 and will fall only slightly in 2025, ending the year at about 4 percent—more than twice as high as in late 2019. Activity in the bond markets suggests that rates could stay near that level for the better part of a decade. Wall Street has begun summing up the situation with a simple phrase: “higher for longer.”
As jarring as 5 percent interest may seem, by historical standards it is pretty modest and, believe it or not, represents a healthy adjustment. America since the Great Recession has been living through an anomalous period of super-low rates that contributed to widening inequality and speculative-asset bubbles. Higher-for-longer should herald a fairer, more sustainable economy. Americans just have to survive the transition. Because before we get to the good place, higher-for-longer is going to feel bad—or at least very weird. Rates haven’t been this high since George W. Bush was president and Taylor Swift was in elementary school. At this point, nearly every facet of the American economy has reshaped itself around near-zero interest rates. As with any dependency, withdrawal will be painful.
The core irony of raising rates to tame inflation is that higher rates can make major purchases—like a car or, especially, a house—more expensive, because most people take out loans to make them. In other words, the cure for inflation may itself be experienced as inflation. In January 2021, the interest rate on a 30-year fixed home mortgage reached a record low of 2.65 percent. Today, it is just over 7 percent. In theory, higher borrowing costs are supposed to cool prices. Instead, they’ve hardly budged. With rates spiking, many homeowners have decided to stay put to preserve the cheap mortgages they secured when rates were low. The resulting restriction of supply has led to the slowest pace of existing home sales since the height of the Great Recession, keeping sticker prices high even as the cost of a mortgage has ballooned. This double whammy has produced the most punishing housing market in at least a generation: Buyers can’t afford to buy, and owners feel stuck in place. As my colleague Annie Lowrey points out, the market could be bleak until the 2030s.
Higher borrowing costs can hurt in less obvious ways, too. Jesse Jenkins, who leads the Princeton ZERO Lab, estimates that higher-for-longer will increase the cost of renewable-energy projects by 20 to 30 percent. In just the past few months, two large offshore wind projects in New Jersey and three in New England—which together would have accounted for nearly one-fifth of President Joe Biden’s 2023 offshore wind-power target—have been canceled because of soaring costs. The world’s largest borrower is also feeling the squeeze. Thanks to rising rates, the U.S. government will pay $659 billion in interest on the national debt this year, nearly as much as it spends on Medicare or national defense.
But the most alarming potential consequence of higher-for-longer lies in the pressure it puts on the financial system. The collapse of Silicon Valley Bank, First Republic, and Signature Bank earlier this year was largely a story about interest rates: When rates went up in 2022, existing government bonds, which had lower rates, lost value. That inflicted huge paper losses on Silicon Valley Bank, triggering a bank run. A wider crisis was averted, but banks remain vulnerable to future shocks. Regulators worry that additional pressure on balance sheets—from, say, a collapse in commercial real estate—could trigger a larger round of bank runs, with damage spilling over into the broader economy. “Eventually,” says Mark Zandi, the chief economist at Moody’s Analytics, “something could break.”
And yet, higher-for-longer appears to be worth the risk. To understand why, it helps to go back to the origins of the previous regime. In 2008, during the depths of the financial crisis, the Fed cut interest rates to zero as part of a desperate bid to avert a second Great Depression. (It also began buying securities itself in an effort to push effective interest rates below zero, a program called “quantitative easing.”) This “zero interest-rate policy”—which became known as ZIRP—was meant to be a stopgap. But as it became clear that the economy needed more help, and a Tea Party–controlled Congress wasn’t going to pass any more stimulus spending, the Fed decided to keep ZIRP in place indefinitely.
The idea behind ZIRP was to encourage spending and, in turn, create new jobs. At the most basic level, the policy made borrowing money extremely cheap. But the flip side was that investors could no longer earn nice returns by simply stashing their money in safe assets such as U.S. Treasury bills. With rates at or near zero, they had to find riskier investments—things like publicly traded stocks or leveraged buyouts or luxury-condo developments. The Fed believed that this would trigger a flood of new investment that would send asset prices soaring and generate what economists call “wealth effects.” People who owned property or stocks would see the value of their portfolios rise, encouraging them to go out and spend more money, ultimately helping to speed along the recovery.
The Fed got the first part right. Almost every single asset class, whether real estate or private equity or cryptocurrency, soared in value in what became known as “the everything bubble.” The stock market more than tripled from 2009 to 2019, and the value of Netflix, Tesla, and Amazon each grew by more than 2,000 percent. But the robust recovery did not materialize. For much of the decade, GDP and wage growth were anemic. The share of working-age Americans with a job didn’t recover from its pre-crisis levels until the fall of 2019.
Instead, because assets like stocks and real estate are disproportionately held by the rich, ZIRP helped produce the largest spike in wealth inequality in postwar American history. From 2007 to 2019, according to calculations by the economist Austin Clemens based on Federal Reserve data, the wealthiest 1 percent of Americans saw their net worth increase by 46 percent, while the bottom half saw only an 8 percent increase. A report from the McKinsey Global Institute, not exactly known as a bastion of economic populism, calculated that from 2007 to 2012, the Fed’s policies created a benefit for corporate borrowers worth about $310 billion, whereas households that tried to save money were penalized by about $360 billion. The journalist Christopher Leonard wrote in his 2022 book, The Lords of Easy Money, that “no single policy did more to widen the divide between the rich and poor” than ZIRP.
ZIRP transformed the American business environment in jarring ways. With borrowing cheap and the market booming, established corporations realized they could exploit financial tactics such as stock buybacks to boost earnings per share without improving their underlying business. Meanwhile, riding a wave of cheap money, Uber, WeWork, and other start-ups burned through billions of dollars of venture capital, pushing entire industries toward hard-to-sustain business models in the process. The private-equity industry, infamous for its debt-heavy leveraged buyouts, began eating up more and more of the economy. Desperation for higher returns also allowed speculative assets including cryptocurrencies and NFTs to attract trillions of dollars, only to collapse spectacularly.
The return of higher rates should help the economy course-correct. More money will flow to long-term investments and sustainable companies instead of speculative assets and impractical start-ups. Companies looking to boost their stock price will have to win new customers or develop better products instead of relying on financial engineering. The gains of economic growth will be more widely spread because less money will be funneled into assets owned mostly by the rich.
Today’s higher rates also signal an underlying economic health that the ZIRP era lacked. The Fed is only comfortable keeping rates higher for longer because America’s post-pandemic recovery has been so strong, thanks to a generous helping of fiscal stimulus. Unemployment has remained at historic lows. Manufacturing is off the charts. Wage gains for lower-paid workers have rolled back about 40 percent of the rise in income inequality that has occurred since the 1980s. In terms of growth, inflation, and employment, the U.S. is doing much better than other rich countries.
Americans used to cheap mortgages and a bonkers stock market understandably might not see all of this as good news. And the risk remains that higher rates trigger the kind of financial crisis that necessitated low rates in the first place. But we shouldn’t pine for the ZIRP era. That was the product of a crisis that our leaders failed to solve. As strange as it is to say, higher-for-longer is what it looks like when things are going right.