Analysis: Five reasons why the Federal Reserve maintained high interest rates, but the U.S. GDP recorded a significant increase in the third quarter

After so many interest rate hikes, the US economy should not have expanded so fast, or at all. But the Commerce Department reported on Thursday that, despite the difficulties, the economy grew at an annualised rate of nearly 5 per cent last quarter, more than double the rate of the previous quarter.

In response to inflation, which hit a 40-year high of 9.1% in June 2022, the Federal Reserve sharply raised interest rates to their highest level in 22 years in 10 months.

By raising the cost of borrowing for businesses and consumers, the purpose of raising rates is to get people to cut spending. For a while, many economists worried that the Federal Reserve would raise rates too much and too fast, triggering a recession.

"It's somewhat mysterious," said David Beckworth, a senior fellow at the Mocatus Center at George Mason University. "Given the pace of interest rate increases, I would expect more damage to the economy now."

Here are the reasons why the economy continues to exceed expectations, as summarized by economists:

First, many people are spared the pain caused by interest rate hikes

The Fed's power to raise rates is limited by many consumers who are not squeezed by rate hikes because their mortgage and lending rates are locked in at lower levels. That makes them "relatively immune to high rates," Beckworth, a former Treasury economist, told CNN.

Two years ago, millions of Americans refinanced their mortgages at rates of 4 per cent or less. Now the average rate on a 30-year fixed-rate mortgage is close to 8 per cent.

Second, the family's economic situation is relatively good

Another reason why the economy grew so fast last quarter is that, all things considered, people did rather well.

Although the unemployment rate has risen slightly in recent months, it remains near its lowest level in half a century, and people are in jobs that pay far more than they did before the pandemic.

With some remaining stimulus money, households have nearly $3 trillion more in cash than they did three years ago, according to the Federal Reserve's quarterly report, which tracks how much cash households have on hand.

"Because consumer balance sheets are so strong, there's a lot of spending to be done," said Courtney Shupert, an economist at MacroPolicy Perspectives, the biggest driver of economic growth last month.

III. Increased productivity in the United States

According to second-quarter data from the Labor Department, which tracks output per worker per hour, worker productivity is improving. Schupert told CNN that's helping the economy grow.

She said that the result of business investment in the past few years has been an increase in productivity, and the increase in investment has been even more due to the epidemic and the tight labor market.

Lower staff turnover has also had an impact, she added: "We saw from the earnings report that most teams are now properly staffed after productivity was disrupted by high turnover."

Fourth, the Federal Reserve has not done enough to raise interest rates

Mr. Beckworth said the fact that the economy was still so strong in the face of so many rate rises could suggest the Fed was not doing enough to "cool the economy".

That said, without further rate hikes, the risk of further acceleration in inflation could grow. But on the other hand, there is also reason to allow time to tell whether the Fed needs to do more

That is because of what economists call "long and variable lags," an unknown but potentially long time before central banks' actions are felt across the economy.

Fifth, there may be errors in good data

Still, there are good reasons to question Thursday's gross domestic product data. That's not to say the Commerce Department misstated last quarter's growth rate. But Thursday's figure is a preliminary estimate, subject to two subsequent revisions.

The revisions could significantly change the state of the economy as told in the GDP report. For example, the Commerce Department initially reported that economic growth slowed to an annualized rate of 1.1% in Quarter 1. However, the figure was revised to 2%, indicating that the economy grew in the quarter.

The third-quarter GDP data is likely to be revised downward, but it is unlikely to have a significant impact. There are a lot of potential forces here. But there is one potentially significant weakness: inventories. Inventory accumulation rose sharply last quarter, contributing 1.3 percentage points, or 27%, to GDP growth.

EJ Antoni, an economist at the Heritage Foundation, a conservative think-tank, sees this as a sign that "companies are stockpiling to avoid future price increases". "This increases GDP today, but reduces it tomorrow and does not increase long-term growth," he said on Thursday. All told, he called the report "a classic case of short-term economic growth". But economic growth is not sustainable. "