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Going into 2023, there was much talk of a looming recession. In the US, the Fed funds rate had been lifted from zero to 4.25%, the term premium was sharply negative, and growth estimates were adjusted sharply downwards.

As it happens, after yet another percentage point added to the Fed funds rate, US growth likely accelerated (!) in 2023. Other advanced economies also seemed to escape recession, with the possible and notable exception of Germany.

What happened?

Maybe interest rates don’t work the way everybody believes they do. It is commonly assumed, and has been for 200 years, that lower interest rates stimulate both growth and inflation, and vice versa. After all, that’s why rates have been increased now. And it does make intuitive sense.

Almost exactly 100 years ago, British economist Alfred Herbert Gibson noted that higher rates were in fact associated with higher prices, not lower, which is known as Gibson’s paradox. But after Keynes, few took notice.

The extremely low, or negative, rates in later years have again prodded some economists to question the impact of interest rates. In 2019, Lawrence Summers and Anna Stansbury wrote in the Guardian that “reducing interest rates may not be merely insufficient, but actually counterproductive, as a response to secular stagnation”. Lower rates might reduce credit growth, lead to inefficient capital allocation, and impede competition.

And this past fall, an article in the International Journal of Finance & Economics implied that we should really rethink our ideas of interest rates. The authors analysed the relationship between nominal interest rates and real economic activity in 19 industrialised and emerging economies (including Denmark and Sweden, but not Norway) going back, where possible, to 1955. Rates ranged from overnight call rates to 10-year government bond yields, while growth was represented by monthly data on industrial production.

Fast forward to their conclusions:

The correlation between economic growth and interest rates is not negative but positive in virtually all countries examined over most time periods.

When significant, the majority of evidence suggests that the causal link does not run from interest rates to economic growth, but more likely from economic growth to interest rates.

Pause a second to reflect on these conclusions. The first one says that with higher interest rates, we have typically seen higher growth, not lower. The relationship (dynamic conditional correlation, if you’re interested) was stronger for longer rates, which are typically market-based. The authors suggest that the beneficial impact of higher rates may be due to a steepening of the yield curve which stimulates credit growth.

The second conclusion suggests that this correlation is due to good growth allowing for high interest rates, a possibility that is left undiscussed. Nothing in their article indicates that lowering interest rates fuels growth, however. If so, increasing interest rates should not hurt growth either – which may just be the solution to the apparent growth puzzle.

I harbour some doubts, seeing for instance how higher rates hurt household consumption, but it’s always useful to have your paradigms challenged. Either way, their research provides arguments for thinking that higher rates aren’t that detrimental after all.

On present estimates, GDP growth in advanced economies will be little changed from 2023 to 2024. Similarly, earnings estimates for listed companies are holding up, signalling there’s no earnings recession ahead. Estimated earnings growth has actually been very stable for some time now, at least for the major markets (in Norway, even aggregate figures are very much influenced by the oil price).

So, why did the S&P 500 dance so slavishly to the tune of the US 10-year yield last year (correlation of almost -0.8!)?

Pricing. Multiples went up and down according to the shifting winds of interest rate projections. I’d be hard put to call that anything but noise. After a year of staring at interest rates, we ended the year with the US 10-year yield at 3.88% – in contrast to, well, exactly 3.88% one year before.

Then again … why should we care?


“Are lower interest rates really associated with higher growth? New empirical evidence on the interest rate thesis from 19 countries”

Kang-Soek Lee, Richard A. Werner

International Journal of Finance & Economics, October 2023