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What if I told you that interest rates and their effect on the economy is in some ways a science and in other ways, a mystery? From American Public Media, this is Marketplace. In New York, I'm Kristen Schwab in for Kai Risdahl. It's Wednesday, July 17th. Good to have you with us.
As we tip into the second half of 2024, the time left for the Fed to start cutting interest rates this year is shrinking. Once upon a time, the Fed signaled the possibility of four rate cuts, whittled down to maybe two and now possibly just one. There are a total of 10 Fed speeches on the calendar this week. And today, two regional Fed presidents said the bank is getting closer to cutting interest.
All that considered, it has been a slower than expected slog to get inflation down to the target rate of 2%. But hey, at least those high interest rates are doing their job. Or are they? Are they affecting the economy the way we think they're supposed to? Roger Karma is a staff writer at The Atlantic. He had a story the other day with the headline, The Federal Reserve's Little Secret. We got him on the line. Thanks for joining us.
It's great to be here. Thanks for having me. So I'm going to step on the secret that you allude to in your title and tell everyone that basically you talk to a bunch of economists who say no one knows exactly how interest rates work or whether they work at all. And my question is, what? I think that is the exact right question. So really, when you look at or read economic textbooks, there are two big theories about how interest rates work.
Both of these sort of go back to the 1970s and 1980s, right? We've all heard the story of inflation reaches these record highs, 15% at one point. Then the new Fed chair, Paul Volcker, comes in. He raises interest rates, which raise borrowing costs, which cause people to spend less, and
employers to lay people off and you end up getting what I call this chain reaction through the economy that results in a recession. And if inflation is too much money chasing too few goods, this reduces the amount of money in the economy and voila, inflation disappears. Everyone is happy. Paul Volcker goes down as the hero who saved the economy.
And it is why in 2022, when the Fed started raising interest rates, everyone predicted a recession. And it didn't happen. So we have this real mystery on our hands where inflation did come down, but all the sort of signals or all the pieces of evidence of that interest rates had worked to achieve that outcome just didn't materialize.
Well, before we get into what we don't know about interest rates, what do we know for certain or do we actually, do we know? Can we link those things together about that chain reaction? So what interest rates mechanically do is they change the rate at which banks can borrow money from each other, right? This is called the federal funds rate. And when that goes
goes up, then all kinds of consumer loan products go up, right? Mortgages, loans that businesses get. These are things that we actually see happening in the economy. I think they also...
You see pretty clearly in the data, they restrict certain kinds of investment, right? Like investment in housing, investment in building new equipment has gone down. But the other steps in that chain reaction, it's a lot harder to see. And what did economists admit to you that they don't know? Oh, my gosh. Well...
I think what they – almost every single economist I talked to for this piece, everyone kind of shrugged their shoulders and said we actually don't understand the role that interest rates played in the disinflation of the past few years. Maybe it operated through the second theory that I alluded to called expectations. But at the end of the day, anyone who tells you they know for certain is probably blowing smoke.
You were talking about the chain reaction that interest rates set off earlier. In your story, you spend some time talking about a very interest rate sensitive area, which is housing.
and how interest rates haven't had the traditional effect on housing prices they usually do. What's happening there? Oh, the housing story is another one of these areas where I think there's a lot of confusion and no one really quite knows what to think. So what you'd expect when interest rates go up, mortgage rates go up, that significantly increases the cost of purchasing a home.
And so what you expect is demand for housing to go down. If there's less people looking to buy houses, you'll see prices stabilize. But what has also happened, because the Fed raised interest rates so quickly, you have a lot of people who already bought homes when interest rates were low. They already locked in very low interest rates.
And therefore, now that interest rates are up, they don't want to move. And what that means is that even if demand for housing has gone down, supply is also going way down. There's just a lot less houses available. And when supply is restricted, that tends to put upward pressure on prices. That tends to make things more expensive. Another pillar of interest rates you talk about, there's the chain reaction. There's also...
just the belief that they work. I guess my question is, how much do interest rates work simply because people believe in them?
So this is a great question. And this is always one of the things that I've found so incredibly and wonderfully strange about interest rates, is that when you really push economists, they will basically say that a major reason why interest rates work is that they are equivalent of a mass Jedi mind trick. By convincing everyone that inflation is going to be under control,
people stop expecting inflation. So in 2022, one of the arguments that economists will make is, look, what Jerome Powell and the Federal Reserve did by raising interest rates relatively early is they basically sent the signal to everyone, look, we got this, it's under control. And that's a reason why inflation never took off in the first place, because all of us sort of expected that, look,
Prices aren't going to keep increasing. The Fed's going to bring a recession. So let's stop spending. And then poof, inflation disappeared. If we're not exactly sure or the economists in your story say they're not exactly sure how interest rates work, are there other tools on the table that we could turn to instead? So in theory, there are.
You can think of policies that either increase the amount of goods or decrease the amount of money. I think the difficulty with the demand side solutions like a progressive consumption tax is how the hell are you going to pass anything like that, right? Americans are already upset enough about high prices. A tax sounds like more high prices.
And so politically, it's extremely difficult. I think one of the reasons the Fed has become, to quote the economist Mohamed El-Aryan, the only game in town is because Congress has become increasingly paralyzed and crippled in the face of economic challenges. And so with the inability to pass anything else, we have to turn to a body that is independent from politics and whether or not we think their tool is the most effective one.
Roger Karma is a staff writer at The Atlantic. Roger, thanks again for chatting. Thank you so much for having me, Kristen. It was a pleasure. Wall Street today couldn't decide if interest rates work the way we expect them to either. We'll have the details when we do the numbers.
We just talked a bit about housing and interest rates. That because the cost of borrowing went from very low to very high, a lot of homeowners aren't moving and a lot of renters aren't buying. And how that's made what's actually on the market pretty unattainable. Realtor.com figures this is the least affordable housing market in 40 years. Which makes this next statement kind of perplexing. First-time homebuyers are a growing share of the market.
Marketplace's Amy Scott looked into what's going on. Joy Suszynski carries a potted purple orchid up the front steps of a brick row house in Baltimore's Hamden neighborhood and rings the bell. Thank you so much for having us over. Thanks for having us. Come on in. Hi. Suszynski is an associate broker with Compass Real Estate and recently helped Lauren and Michael James buy this house, their first. Well, here you go. Thanks.
It looks completely different. I can't wait to see what else you've done. They've done a lot. Well, Michael, who's a professional remodeler and handyman, has. That's a big reason they could buy this house. It needed a lot of work. There was like five layers of wallpaper.
and paint and plaster on all of these walls. He stripped the walls, tore out the gray vinyl flooring, and restored the original wood, some of which was rotting, basically undoing a lot of the previous owner's cosmetic fixes. Yeah, it was a very cheap flip.
For Lauren, a psychotherapist, it's been a four-year saga to become a homeowner. She started looking for a house in 2020.
Because I'm self-employed, I was denied. I needed two years of tax returns. So I put those dreams on the shelf and bought a car instead. She built up her therapy practice and her income. Then she and Mike got married and started looking together back in March, only to run headlong into one of the toughest housing markets in decades.
There were not very many houses on the market, especially things that we liked. We would see homes in the area, but they were way out of our price range. They found one place they liked at the top of their price range and got outbid by $30,000. So when this three-bedroom flip went on the market, they made an offer that day to buy it as is and waived their right to an inspection. I wouldn't advise people to do that.
I really wouldn't. But because I could walk around here and I could see what needed to be done, we knew what we'd be in for.
Mike and Lauren are those rare first-time buyers who found a way in what can feel like an impossible market. First-timers made up 32% of all homebuyers last year, according to the National Association of Realtors. That's up from just 26% the year before, an all-time low. But Jessica Lautz, the group's VP of research, says it's still well below the long-term average of almost 40%.
They've really struggled to enter into the market, whether that's housing affordability, inventory, student loan debt, child care costs. All of these things are piling on for first-time homebuyers and making it quite difficult to save for a down payment and enter into homeownership. Lautz says those who manage to pull it off are older than the typical first-time buyers in the past and wealthier. In
In fact, their household income is about $20,000 more than household income of first-time homebuyers the past year. They're more likely to use stocks for their down payment. It's an interesting first-time homebuyer that we see this year.
Laut says one reason the share of first-time buyers has been growing recently is because so many existing homeowners who bought when interest rates were low feel trapped. William Gordon is an agent with the Gordon team in Bakersfield, California. I would consider myself a little bit rate locked. Like now that we have a baby number two coming in November.
Trading up for a bigger house would mean trading in his 2.75% interest rate for something closer to $7. We pay $2,500 a month all in. If we were to buy the same house today, we'd easily be paying $4,000 a month.
Gordon is seeing some loosening in his market as sellers come to terms with higher rates and can't wait any longer. At the start of the year, there were just 400 or 500 active listings in a city of about 400,000. Now it's almost double. A young family he's been working with is closing on their first house later this month. They'd been looking since November. I'm Amy Scott for Marketplace.
Yesterday, we talked retail sales, which were flat. Here's another important number related to the stuff retailers sell. The Census Bureau says in May, businesses added more stock to their inventory than economists had been expecting, up half a percent compared to three-tenths percent in April.
Good news, that short-term increase means despite higher interest rates, businesses have enough confidence in the economy to invest more. Maybe not so good news? In the long term, well, things are a little more complicated. Here's Marketplace's Kaylee Wells.
An increase in inventory can be a good thing. That does mean that investment is increasing, which we will immediately see impact GDP in a positive way. But Christina DiPasquale, who teaches economics at Johns Hopkins University, says sometimes the increase is unplanned, meaning businesses didn't sell everything they wanted to sell and their inventory grew unintentionally.
Oftentimes, that can be a signal of perhaps waning consumer demand, which then would be a negative impact on the economy down the road. But there are a bunch of other variables in this equation, says senior economist Megan Schoenberger with KPMG. There's also the fact that new tariffs went into effect in May. And so there was a lot of stocking up of those affected products.
Namely, products from China. She says auto dealers have also been adding inventory because they're still playing catch-up after the pandemic supply chain debacle. And if you're already seeing Halloween decorations on the shelves, blame the weather. They're expecting a record-breaking storm season and that there's going to be a lot more logistical problems. So businesses stocked up before the weather gets bad.
So yes, an increase in inventory can spell bad news. But... I don't necessarily know if there's any red light flashing.
John Quinterno is a public policy professor at Duke University. He says business inventories have been depressed since the pandemic, but now they're... Getting a little closer to where it was sort of pre-COVID, and it's sort of in a range that I don't think is unusual. Quinterno says broader concern about lasting economic implications of rising inventories is only warranted if the trend continues. I'm Kaylee Wells for Marketplace.
Coming up... People were just burnt out. And eventually that burnout shows up in the economy. But first, let's do the numbers.
The Dow Jones Industrial Average rose 243 points, 0.6%, to finish at 41,198. The Nasdaq subtracted 512 points, 2.75%, to close at 17,996. And the S&P 500 lost 78 points, 1.4%, to end at 5588.
The Dow was an outlier among the three indices, thanks in part to two companies in health care. Johnson & Johnson pocketed 3.7% after announcing second quarter earnings that beat analysts' estimates. And UnitedHealth Group added 4.4% that also beat profit estimates for the quarter. And Wall Street is betting that the chance of a second Trump administration will ease the regulatory burden on the insurer.
Bonds rose. The yield on the 10-year T-note fell to 4.15%. You're listening to Marketplace.
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This is Marketplace. I'm Kristen Schwab. Amy Scott was telling us earlier about what it's like to be a first-time homebuyer right now. Here's something that could translate to a little relief sometime in the future. Today we learned that housing starts and building permits were higher in June than in May, though lower than this time a year ago. Also, housing completions – that's the number of newly finished single-family homes and multi-family buildings –
Housing completions went way up, both month over month and year over year. Marketplace's Samantha Fields has more on what this means for the market.
Builders finished a lot of new homes and apartment buildings last month, many more than this time last year. The reason really is that there is so much stuff that was just in the pipeline. Chen Zhao, economics research lead at Redfin, says construction on much of this housing that's coming online now started a while ago. There was a kind of a big building boom coming out of the pandemic because there was so much demand for housing. So builders were trying to keep up with that demand.
But it was taking them a long time to build. Because the cost of supplies was high, there was a shortage of supplies, and there was a shortage of construction labor. That logjam is still clearing.
Logan Modishami, lead analyst at HousingWire, says all the new housing that's been completed lately, especially on the multifamily side, has been good for the economy. The best way to deal with inflation is supply, right? So you want to build as much as you can and get those homes out there for people to live in and bring down the rise of rents.
That is finally happening. But I think we may be sort of at peak. Lisa Sturtevant, chief economist at Bright MLS, says if you look at recent trends in permits and starts... We're actually starting to see a slowdown, particularly on the multifamily side, when it comes to the number of new units that are kind of in the pipeline. But Orfei Divungi, senior economist at Zillow, says that could shift again soon. If you look ahead, you see inflation cooling.
and the cool down in inflation will likely lead to mortgage rates easing somewhat. Which will likely increase demand and be an incentive for builders to start building more again. Divungi says that would be a good thing for affordability, which has gotten much worse in the last few years. The solution, the long-term solution, is to continue to build housing. We
We saw it in the multifamily space where basically as we built a bunch of apartments, rent growth slowed. Now, he says, that's what needs to happen with single family homes. I'm Samantha Fields for Marketplace.
The job market in the U.S. has been expanding at a pretty healthy pace for a couple years now. It added over 200,000 jobs in June alone. And gains in the public sector have been a key piece of that growth. Governments at the federal, state, and local levels have been on a hiring spree because they're still bouncing back from the labor market shocks caused by the pandemic. Marketplace's Henry Epp looks at how much ground governments have gained and the challenges ahead.
It took a while for the pandemic to start driving people from the state workforce in Vermont, says Commissioner of Human Resources Beth Fastigy. In the early months of lockdown, she says, a lot of workers who could have left stayed on. Folks who likely delayed retirement because were public service and really wanted help, they stuck it out for quite a while. But after a year or so of working through a state of emergency, those attitudes started to change. People were just burnt out.
Especially people in government jobs that never went remote. Highway transportation workers, the snowplow drivers, the corrections officers, the nurses.
And so, Fastigi says, by 2022, the turnover rate among state government workers in Vermont topped 15 percent, about four percentage points above normal. The same thing was happening to state and local governments all over the country around that time. Some workers were retiring, while others were opting for higher wages in the private sector. A lot of times they were losing corrections officers to the McDonald's down the road.
Leslie Scott Parker is head of the National Association of State Personnel Executives. Private businesses quickly boosted salaries to try to combat labor shortages in 2021 and 22, but governments, not so much. Government, you know, typically doesn't work quite as quickly as the private sector. It was up to legislators to increase wages, and that took time, says Liz Farmer, who focuses on state fiscal policy at the Pew Charitable Trusts.
It's like governments were kind of sitting on the sidelines waiting to get all of their ducks in a row. And now it's their turn. A majority of states approved across-the-board salary increases in 2023 and this year, she says. In Vermont, for example, many state employees just got a 4.5% pay boost. And that's making a difference.
And so what we've seen the last year and a half or so is that kind of the explosion that we saw in the private sector in terms of jobs and wage growth. Now it's happening in the government sector. Government positions have made up about one in five new jobs added to the labor market this year, Farmer says. And states and cities have offered more than just higher pay. Some governments have also given out hiring and referral bonuses, boosted benefits and offered remote or hybrid work.
But even as government hiring has risen, the process of filling those jobs hasn't exactly been easy. We're seeing that people are looking at the jobs, but we're not seeing that they're necessarily applying for the jobs.
Reid Walsh is with the company NeoGov, which provides software for public sector HR departments. She says fewer people have been applying for government positions than before the pandemic. Part of the problem is that government job listings can be pretty jargony. When we say things such as Administrative Officer 1 or Procurement Specialist 2, you know, those aren't necessarily translatable to people's everyday nomenclature.
Walsh says NeoGov has worked with a few states to rewrite some job descriptions to make them look more like postings in the private sector. We saw a lift. We saw about 18 percent increase in those job applications when we did that. Governments are facing another problem. Their workforces are aging. Gerald Young is a researcher with the Mission Square Research Institute, which focuses on state and local governments. He says HR managers who the institute surveyed expect retirements to surge again soon.
More than half are saying that they're expecting the largest wave of retirees to happen in the next few years. Filling those positions could mean the public sector remains a big force in the labor market. I'm Henry Epp for Marketplace.
This final note on the way out, a tidbit from one of the other big info releases today, the Fed's Beige Book. That's its series of anecdotal data taken from all 12 of the regional Federal Reserve banks. It comes out eight times a year.
Not to beat the housing news over your head, but its impacts reach well beyond the walls of a home. This comes from the Atlanta Fed. Employers in South Florida and Nashville say the lack of housing affordability has made it harder for them to attract and retain workers. So they're turning to automation and outsourcing instead.
And this one from New York, where I live. Instead of vacationing stateside, many Americans are traveling overseas and taking advantage of favorable exchange rates detracting from tourism in New York City. I have noticed the city has been kind of empty this summer.
Our media production team includes Brian Allison, Jake Cherry, Jessen Duller, Drew Jostad, Gary O'Keefe, Charlton Thorpe, Juan Carlos Torado and Becca Weinman. Jeff Peters is the manager of media production. And I'm Kristen Schwab. We'll be back tomorrow. This is 8 p.m. Understanding personal finance can feel like an impossible task, but it doesn't have to be that way.
I'm Janelia Espinal, and on Financially Inclined, I'll guide you through simple money lessons that will change your financial future. Learn about credit scores, how to avoid scams, and why you need a savings account. Plus, we explore the brain science behind FOMO and what you can do to make smarter money decisions. Listen to Financially Inclined wherever you get your podcasts.