“I am puzzled by the paradox that high interest rates are supposed to reduce inflation (by increasing borrowing cost, reducing demand, slowing consumer spending, etc.), yet it seems that currently we have interest rates at a very high level (ask the housing market), though nowhere near what was considered the norm back in the day. And as you both have pointed out, there is still plenty of private capital out there, as well as apparently some residue of the COVID helicopter monies airdropped indiscriminately on our populace in 2020. Equity markets are closing at highs and valuations are certainly “inflated” these days – though that is not necessarily “inflation.” So is the interest rate a lower-order effect than the sheer availability of capital, or what is causing the disconnect with current high levels of interest not bringing down inflation? Why aren’t higher interest rates lowering inflation?”
~ Miles F.
Thank you for your well-posed question. Monetary policy is certainly designed to alter behavior by manipulating the cost and availability of capital, but ultimately, there are also free market forces driving actual demand and banks’ desire to fund new loans. Higher rates do make real estate financing less desirable as borrowing costs exceed cap rates, as you point out. We have seen building permits stall, existing home sales anemic, and housing inventory swell because of this. Higher rates also caused the loan books on bank balance sheets to depreciate, and this is what ultimately led to SVB and First Republic banks failing in 2023. So, there has been an effect on housing and the economy.
That said, the fact that 80% of outstanding home mortgages were refinanced in the mid 3% range several years ago, that 39% of homes are owned outright, and that there are record high levels of protective equity, is why pricing itself has been so resilient. With housing being such a large part of the economy, and with mortgages being the largest interest-sensitive component of consumer balance sheets, it plays into your question on overall inflation being less affected.
Lastly, Monetary Policy works with a lag. Remember the other side of that inflation coin when we had some of the lowest inflation in all of history, when rates were basically near 0% post-GFC. To be fair, inflation technically has moved down from over 9% to 2.7% in this rate cycle, so there has been a real effect, albeit perhaps more muted than some would have predicted. The tough part now for the Fed is to land the ship with getting rates back to neutral before labor deteriorates.
~ Brian T. Szytel, September 3, 2025
