Allison Schrager on Why We Can't Have Nice Things
Higher interest rates will reshape spending behavior, from the federal government to corporate boardrooms to your kitchen table.
You may have seen Derek Thompson’s article in The Atlantic last week about “the end of the millennial lifestyle subsidy” — his term for the rapid recent rise in prices for Uber rides and other services whose price had long been suppressed by two factors: workers willing to provide them for low hourly wages; and investors willing to fund companies that priced the services so low that they lost money despite paying those low hourly wages.
Part of the explanation for the end of this era is simple. A tight labor market means you now need to pay those workers more; investors have suddenly refocused on the idea that investments actually need to make money; and the cost of inputs these businesses need, such as gasoline, is rising sharply, too. That all has combined to mean sharply higher prices for certain things that had remained puzzlingly cheap for a long time.
Rising interest rates have been important for reminding businesses (and their venture-capital investors) on the importance of actually making money. But I find the story about why it’s suddenly important again for businesses to make money to be a little strange.
Higher rates raise the cost of capital for businesses. If they borrow, they have to pay more interest on the borrowings; if they’re financed by equity, they have to deal with the fact that equity investors expect higher returns as the alternative of holding debt becomes more attractive in the higher-rate environment. And more expensive capital means you have to be more sure your business idea is good, so you can pay your investors what it will cost to get their money.
But business activities that lose money before financing costs are bad business ideas in any rate environment. There’s the old joke about “losing money on every transaction but making it up on volume” that Uber turned into an actual business strategy, but low-interest debt can’t wring profits from an enterprise that loses money before even taking account of interest any more than a higher volume of money-losing transactions can.
So I think the sunset of the “millennial lifestyle subsidy” is happening not so much because business models that were good in a low-rate environment went bad — it’s because the stupidity of some business models could be papered over in a low-rate environment, and now that’s untenable. If we’re lucky, this phenomenon will de-pants some of the most wasteful agencies in the public sector, too: Paying five times as much as what Europeans pay to dig subway tunnels isn’t a good idea in any rate environment, but higher rates on municipal bonds could be the nudge certain public authorities need to actually figure out how to build cheaper.
Probably not — instead of innovating, they’ll probably just build less. But hope springs eternal.
In that spirit, this week’s episode of the Very Serious podcast is a conversation with financial economist Allison Schrager about interest rates and how their sharp rise is going to affect you, though effects on business, government, and consumer behavior. Higher rates — combined with inflation — have a lot of consumers taking a hard look at their budgets and figuring out what nice things they can afford to keep doing, and what they’ll have to cut back on. This is in large part what’s intended by the Fed’s rate-hiking campaign: Excess consumer demand is fueling inflation, and getting people to cool it a little will hopefully take some of the upward pressure off prices.
But it’s hardly fun. And Allison has some thoughts about how the discipline of higher rates could produce some positive impacts on the economy — and how it could also drive us into recession.
I hope you enjoy the episode and I’d love to know what you think. Leave any questions or responses in the comments section below.
Here are some links to articles we referenced in this episode:
First Citiwide Change Bank SNL skits:
“We’re not going to give you two thousand nickels, unless that meets your particular change needs.” (part one)
“The answer is simple: volume.” (part two)