To understand what is happening with interest rates and the global economy, we have made the case that nothing less than a regime change is taking place, characterized by scarce capital, insufficient aggregate supply, higher inflation and higher interest rates.
Firms, as a result, will need to adjust to a new landscape where rates are higher for longer. Even with all the change, though, the $27 trillion U.S. economy has proven to be resilient as it grows above trend.
But can it continue?
That depends on two major factors that will support a continued economic expansion: productivity and growth in the labor supply.
As interest rates move higher—as seen in the spread between the 10-year and 6-month Treasury notes—the economy will increasingly depend upon sustained productivity growth in the range of 2.5% rather than the 1.5% that prevailed before the pandemic.
This productivity growth is all the more important as the labor supply ebbs in the face of tighter immigration policies and the retirement of the baby boom generation.
Read more of RSM’s insights into the economy and the middle market.
But to achieve sustained productivity growth as rates reset higher, firms will need to invest more in equipment, software and intellectual property. Artificial intelligence, still in its nascent stages, is a vital part of this picture.
Given rising policy uncertainty because of the escalating trade tensions and tighter immigration policies, firms getting the balance right between labor and productivity may well determine the duration of the current economic expansion.
