The Price of Money

Are higher interest rates good or bad?

That’s a good question. Since Ben Bernanke’s press conference three weeks ago interest rates have moved sharply higher. Some note that higher interest rates make it more expensive to borrow and conclude that these rates will make it more expensive to borrow money and put the economy at risk. Others note that higher rates result from a stronger economy, and so they should presage good things to come. Which is it?

Interest rates can be seen as the price of credit. When they’re low, there’s too much supply chasing too little demand, and credit is cheap. Conversely, when they go up, demand is outstripping supply. Since 2008 the Fed has been injecting huge levels of credit into the banking system, but now they’re intimating that the economy is strong enough that monetary spigots may dry up. Friday’s employment number confirmed that the labor market is getting better.

This is a good thing. A stronger US economy means that consumers and businesses are demanding more credit, and the clearing price needs to rise. Higher prices that result from an increase in demand are sustainable.

This question arises every time the economy comes out of the doldrums: will higher rates push it back down? It came up in 2003, and before that in 1994. If history is any guide, the answer is, “no.”

Douglas R. Tengdin, CFA

Chief Investment Officer

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