Unexpected changes in monetary policy can slow the pace of economic activity much more persistently than is commonly believed. In response to a 1% increase in interest rates, output would be about 5% lower after 12 years than it would otherwise be. To provide some context for these numbers, consider some data for the United States. In response to a similar 1% increase in interest rates, after 12 years TFP would be about 3% lower and capital would be about 4% lower. When we separate our interest rate experiments into those that resulted in rate hikes versus those that resulted in lower interest rates, we see that there is no free lunch. The blue line shows that lower interest rates have mostly temporary effects that vanish after a few years, as traditional theories predict.
- Date Posted:
- September 5, 2023
While bank lending plateaued in the U.S., off-shore dollar bank lending has actually contracted outright at a rate not seen since the 2008 financial crisis. Data as of 2023Q1 indicates a year over year decline of $325b in loans with the bulk of the decline concentrated in lending to emerging markets. This is likely due to both supply and demand factors, where borrowers pull back due to higher rates and banks reduce lending due to lower profitability. A similar trend is observed on-shore, where bank lending has been growing at a very sluggish rate. Note that foreign banks may not have access to dollar liquidity backstops like FHLB lending and the discount window, so they may be more cautious than U.S. banks. The reduction in dollar credit is likely contributing to the global manufacturing slump and will remain a significant headwind to global growth.