Interest Rate Cuts: A Path to Economic Recovery

Interest rates function through two main channels: the credit channel and income effects. Increasing interest rates restrict credit access, negatively impacting housing transactions, durable goods demand, construction, and real estate investment, leading to observable declines across developed economies. However, the anticipated income effect of increased borrowing costs on existing debtors did not manifest significantly due to prior deleveraging and terming out of debt, preventing the feared financial distress and credit events. Although bankruptcies and defaults are increasing, this reflects a normalization of the credit system after a period of central bank intervention. As smaller and medium-sized companies face ongoing debt challenges, a reduction in interest rates could invigorate the economy by reversing the damage caused by prior rate hikes, facilitating recovery in affected sectors quickly. Therefore, cuts in interest rates could positively stimulate the economy and mitigate future debt crises.