Why the last mile in the Federal Reserve’s inflation fight has been uphill

It’s been a big day for interest rates globally: Switzerland’s central bank cut its key interest rate by a quarter of a percentage point after signs of moderating inflation there. Meanwhile, Norway’s central bank held rates steady, as did the Bank of England.

Here in the U.S., the Federal Reserve has also decided to keep rates elevated for a year now. The Fed has done this, of course, to fight inflation — and inflation has cooled a bit. But it’s still not all the way down to the Fed’s 2% target. That last mile has been difficult.  

For more on this, let’s turn to Julia Coronado, founder of MacroPolicy Perspectives and a clinical associate professor of finance at The University of Texas at Austin. She spoke with my Marketplace’s Sabri Ben-Achour. The following is an edited transcript of their conversation.

Sabri Ben-Achour: I wanted to run an argument by you that I’ve heard from some quarters that goes something like this: Here in the U.S., we can lock in our debt for a long time — mortgages are 30 years. You can lock in the low rate when rates are low; companies can do the same thing for their debt. So if so much of our debt is locked in, does that make our economy less sensitive to the interest rates that the Fed sets? Is the Fed not as powerful as we think it is?

Julia Coronado: Well what that does is mean that it takes longer for higher interest rates to bite the economy, and it’s spread out over a longer horizon. So as people move — because after all, people will have to move — and business debt, they usually lock it in for something like five years — over time, if interest rates remain high, people will face higher debt costs. But that pain or the impact of those higher rates is spread out over a longer time rather than hitting more immediately.

Ben-Achour: Given that we’ve had low rates for such a long time before the current period, do you think that makes the lag extra long this time around?

Coronado: Yes, definitely — because people will hold on to those low-rate mortgages as long as they can, because we came from record low to multi-decade highs very quickly. And the housing market right now in the U.S. is essentially stuck in most places. That’s not a good equilibrium for the housing market. That tells us that, eventually, people will have to move and we will have to see that turnover and the impact of higher rates. But it is taking a longer time than usual, yeah.

Ben-Achour: Well, does that create a special kind of risk or concern in a way? Because if you have to cool down the wider economy a little you end up cooling down maybe the smaller parts of the economy, the super interest rate-sensitive parts of the economy a lot.

Coronado: Yes, yes. Exactly. So you have people facing very high rates, who have to make those decisions, who have to move and who have to buy a new car face these very high rates that we don’t think we’re going to stay forever at these rates. But the Fed has to keep them there until they can get inflation down, and that’s just taking longer. So it’s a little bit of a chicken-and-egg problem.

Ben-Achour: Is that why it’s so difficult to get that last mile of inflation down?

Coronado: Well, you know, I think that remains to be seen. Housing is an area that also has been slow to see housing inflation, which is the biggest part of inflation, cool down to where it was before the pandemic. All the indications are that it’s going in that direction, it just hasn’t quite shown up yet. But we do see rent growth cooling. We think that will show up sometime probably this year, and that will allow the Fed to move forward with rate cuts.