Asset prices, such as stock prices and interest rates on government bonds, generally respond to changes in monetary policy within hours or minutes. These prices also often respond quickly to forces that affect expectations about monetary policy, such as speeches by central bank officials and data releases — monthly employment and price data — that might help determine the course of future monetary policy.
While asset prices respond quickly, the prices of goods and services as well as real economic activity have longer and more variably lagged responses. One reason for these long and variable lags is that many economic transactions involve prices and quantities that are agreed upon months in advance by the buyer and seller through contracts.
Post-Covid, three developments have potentially weakened the channel of transmission of monetary policy: the excess of household savings, the boom of financing for companies in Covid years, and high profit margins. But these buffers are eroding.
The extra savings that households amassed during the pandemic — thanks to stimulus cheques and lockdowns — are running out. The San Francisco Fed calculated in the US that the savings would have all gone by the end of this year. Bloomberg calculations show that the poorest 80 per cent of the population now have less cash on hand than they did before Covid-19.
Only the 20 per cent of top earners continue to have excess savings today. We know that these US top earners account for 30 per cent to 40 per cent of consumption, but this excess of cash is fading quickly. The past summer saw Americans splurge on a wave of hit entertainment — Barbie and Oppenheimer movies, concert tours by Beyonce and Taylor Swift.
But the recovery in services is almost complete and the strong demand that supported services-oriented economies is now softening. “Winter is coming” with the end of excess of cash, real wage growth under pressure with high commodity and energy prices, as well as the tightening of credit conditions.
Moreover, in 2022, relatively few companies urgently needed to refinance because many used the cheap money on offer at the start of the pandemic to push out debt payments at fixed rates. Activity in the high-yield and investment-grade bond market got crushed last year when the Fed started hiking rates — but it is now starting to recover at much higher interest rates.
