Author: Andrew Berger-Gross
Welcome to the May 2023 edition of NC Economy Watch: an update on what’s happening in the North Carolina economy and what it means for you, brought to you by the Labor & Economic Analysis Division (LEAD) of the NC Department of Commerce.
In this edition of NC Economy Watch we take stock of how high interest rates have affected the North Carolina economy. The Federal Reserve has hiked interest rates at the fastest pace in over 40 years, making it more difficult for businesses and consumers to access credit. So far, our state’s economy has largely held up in the face of tightening credit conditions, but the delayed effects of high interest rates may lead to more serious consequences in the months ahead.
Rising Interest Rates Are Making It Harder to Access Credit
In our last edition in NC Economy Watch, we examined rising prices in our region and nationwide. This month, we focus on the steps the Federal Reserve is taking to fight price inflation and the impact these measures are having so far on our state’s economy.
The primary tool in the Fed’s inflation-fighting toolkit is the federal funds rate, which influences the interest rates consumers and businesses pay on loans. Interest rate increases help counteract inflation by making credit more expensive, leading to slower economic growth and reducing upward pressure on prices. The Fed moved aggressively to halt runaway inflation last year, raising their benchmark rate at the fastest pace in over 40 years [Figure 1]. While the pace of rate increases has slowed in recent months, the federal funds rate remains at its highest level since 2007.
High interest rates raise the cost of doing business and make it more difficult for consumers to obtain loans. The New York Fed’s April 2023 Survey of Consumer Expectations reported that 56% of consumers are having a harder time accessing credit, an increase of 24 percentage points over the share reporting difficulty in December 2021 [Figure 2].
We should expect to see Fed rate hikes hitting hardest in the most interest-rate sensitive sectors of our economy, such as the housing market. Residential home-building activity in North Carolina declined in 2022 as the average interest rate on 30-year mortgages more than doubled [Figure 3]. However, demand for construction workers remained elevated throughout this period, and we’ve seen little indication that weakness in the housing sector has led to a downturn in other, less rate-sensitive sectors of our state’s economy, nor has it done much to cool down our red-hot labor market.
It is likely that a boom in industrial and public works projects is driving continued growth in construction employment, alongside a more recent uptick in residential building activity as mortgage rates have eased slightly. Another possibility is that the effects of turmoil in the housing sector have yet to manifest themselves but could generate more widespread problems in the months ahead. The Great Recession offers a cautionary tale: although a nationwide housing crash began in early 2006, mass layoffs of construction workers didn’t occur until two years later.
In general, Fed rate hikes operate with “long and variable lags”. It can take a long time for interest rate increases to slow economic growth and lower price inflation. Recent turbulence in the banking sector shows how the blowback from high interest rates might not be apparent immediately but can eventually cause sudden and unexpected disruptions.
The Federal Reserve is unlikely to reduce interest rates until inflation is brought back down to their 2% target. In the meantime, high interest rates will continue to serve as a brake on economic growth, potentially leading to a recession. Our hope is that the past year’s rate hikes will work their way through the economy and bring prices under control without inducing a recession—a so-called “soft landing”. As with many of the economic topics we’ve addressed in NC Economy Watch, the potential for a soft landing will be determined largely by our ability to bring the labor market back into balance. Until we succeed at filling a larger share of our near record-high level of job openings, price inflation is likely to persist, leading to further interest rate hikes and heightening the risk of a serious economic downturn in the year to come.
For inquiries and requests, please contact:
Meihui Bodane, Assistant Secretary for Policy, Research and Strategy
NC Department of Commerce, Labor & Economic Analysis Division (LEAD)