How Will Higher Interest Rates Affect the Economy?

Assessing the impact of higher rates on GDP 

To assess the impact of higher rates on economic growth, Goldman Sachs Research began by estimating how each GDP component has typically responded to rising interest rates. The three most rate-sensitive GDP components include: 1) residential investment, 2) consumer spending, and 3) capital expenditure (capex). 

Our analysts find that higher rates tend to weigh most heavily on residential investment, though consumer spending and capital expenditure also contribute meaningfully to the overall drag because they account for much larger shares of GDP (about 65% and 15%, respectively, versus 5% for residential investment). 

Potential impact on residential investment

According to Goldman Sachs Research, higher rates will continue to weigh most heavily on residential investment by further cooling housing demand, which is already expected to stay tepid amid affordability concerns, slowing income growth, and a persistent slowdown in household formation from reduced immigration. Survey-based measures of purchase intentions have declined since early summer. 

Higher mortgage rates will also continue to weigh on housing turnover through the lock-in effect. Because many borrowers refinanced at low rates in 2020 and 2021, the gap between those rates and current mortgage rates imposes a significant cost to moving, since buying a new home would require prepaying the existing low-rate mortgage and taking out a new one at a much higher rate. 

With mortgage rates up more than 1 percentage point since February, over 90% of borrowers now hold mortgages priced below market rates, leaving them with little incentive to move.

Goldman Sachs Research analysts expect higher rates to subtract about 2 percentage points from annualized residential investment growth in the fourth quarter of 2026 and 1 percentage point on average in 2027, though the drag would be roughly twice as large if rates stayed at current levels.

Potential impact on consumer spending

Goldman Sachs Research expects higher interest rates to weigh on consumer spending mainly by reducing demand for durable goods such as recreation goods and motor vehicles, which rely heavily on credit financing.

Although this drag should be partly offset by the modest boost to consumer spending from higher net interest income, our analysts estimate that, on net, higher rates will slow consumer spending growth by 0.2 percentage points through 2027.

This drag, however, would rise substantially if rates were to stay at current levels and continue to weigh on durable goods demand for longer.

Potential impact on capital expenditure

Higher rates also raise firms' marginal cost of funding, weighing on business investment. A growing concern is that higher rates could increasingly affect the AI-driven capex boom that has boosted investment growth in recent quarters, as heavy spending on AI infrastructure has eroded free cash flow and pushed companies to rely more on debt and equity issuance, leaving them more exposed to rising rates.

But hyperscalers' capex, which accounts for over two-thirds of AI-related investment in the US, has so far proven largely insensitive to higher rates and input costs, suggesting these companies are applying high hurdle rates and are unlikely to pull back meaningfully in the near term.

However, across the rest of the economy, companies will need to devote a larger share of revenue to interest expense as they refinance maturing debt at higher rates. 

Goldman Sachs Research estimates the increase in interest expense separately for large companies and small businesses, as the latter are more sensitive to rising rates (about half their debt is variable-rate and reprices quickly). 

Our analysts expect higher interest expense to weigh modestly on capex growth—by about 0.3 percentage points in 2027 and in subsequent years—though the impact could be more than double if rates stayed higher.

Baseline forecast: a modest drag on growth 

Until recently, Goldman Sachs Research’s financial conditions framework suggested that the drag from higher rates was roughly offset by higher equity prices, tighter credit spreads, and a weaker dollar. 

Adding up the effects on housing, consumer spending, and capex, our analysts expect higher rates to subtract about 0.2 percentage points from GDP growth in 2027, leaving the economy still growing close to Goldman Sachs Research’s 2.3% potential growth estimate. 

If current rates persist instead, our analysts estimate the drag on growth would rise to slightly over 0.5 percentage points.

Additional risks from higher interest rates

Goldman Sachs Research sees two additional risks if current rates persist. 

• First, higher rates could weigh on equity prices. Our strategists expect equities to rise slightly over 10% by end-2027 but note that stable rates could limit upside. If equities were roughly flat through 2027 because of higher rates, the missing boost from wealth effects would lower consumer spending growth by just under 0.5 percentage points.  
• Second, higher rates have revived fiscal sustainability concerns. The large primary deficit remains the main driver of the debt-to-GDP ratio, but persistently higher rates would boost interest expenses and push the ratio up faster—raising the odds that deficit reduction becomes necessary sooner to stabilize debt.