Why high interest rates are barely slowing financial markets
Jan 2026
Thought Supply
Perspective shaped by experience
Why do financial markets remain surprisingly resilient despite high interest rates? What role do liquidity, fiscal policy, and the AI investment boom play in shaping risk-taking? And how robust is the international economic order in an increasingly multipolar world? These questions are at the core of the new episode of Thought Supply, a conversation between former governor of the Reserve Bank of India Raghuram G. Rajan and former WTO chief economist Ralph Ossa.
The observation that financial markets have remained remarkably stable despite one of the fastest tightening cycles in recent decades took center stage in the conversation. For Rajan, this stability calls for explanation. While monetary tightening has clearly raised policy rates, overall financial conditions have barely become more restrictive. A key reason, he argues, is the exceptionally high level of liquidity in the system – built up over many years of expansionary monetary policy and still exerting a strong influence.
Liquidity, expectations, and the role of the state
Rajan adds that many market participants continue to expect central banks to step in during times of stress. This implicit backstop reduces perceived risk and increases the willingness to take on larger positions, weakening the dampening effect of higher interest rates compared with earlier cycles. Fiscal policy also plays an important role. Persistently high public debt reflects an expansionary fiscal stance that continues to support aggregate demand.
AI investment between growth hopes and financing risks
Against this backdrop, Rajan and Ossa turn to the surge in investment in artificial intelligence. Rajan notes that the long-term growth potential of these technologies is widely acknowledged. At the same time, it remains unclear when productivity gains will materialize and who will ultimately benefit from them. He is particularly attentive to the growing reliance on debt financing for large AI projects. While many early investments were funded internally, these resources are increasingly insufficient. The combination of credit financing and high asset prices, Rajan warns, makes the system more vulnerable to disruptions.
Fiscal space and the next crisis
Another focus of the discussion is the fiscal implication of these developments. Rajan points out that many advanced economies now face public debt levels around 100 percent of GDP. Rising real interest rates significantly increase debt-servicing costs. Should a new financial crisis occur, large-scale public stabilization measures would likely be required. Whether sufficient fiscal space still exists for such interventions is, in Rajan’s view, an open and increasingly critical question.
Trade, distribution, and the international order
In the final part of the conversation, attention shifts to international trade and the global economic order. Rajan argues that current political tensions around trade and globalization are driven less by their long-run economic effects than by distributional outcomes. While international trade has contributed to declining inequality between countries, adjustment costs within countries have often been insufficiently addressed. This has weakened political support for open markets. In an increasingly multipolar world, Rajan adds, there is also a lack of an actor willing or able to actively stabilize the existing order.
Perspective shaped by experience: Rajan’s career
These views are closely linked to Rajan’s personal and professional trajectory. Growing up between India and Europe, he developed an early interest in development and differences in prosperity. After a career in academic research, he took on responsibility in international economic policymaking as Chief Economist of the International Monetary Fund, where he warned as early as the mid-2000s about systemic risks in the financial system. He later implemented monetary and regulatory reforms under acute crisis pressure as Governor of the Reserve Bank of India. Today, Raghuram Rajan is a professor at the University of Chicago Booth School of Business.
Takeaway
The conversation, held on the sidelines of the 2025 UBS Center Forum for Economic Dialogue, underscores that today’s economic policy challenges cannot be viewed in isolation: monetary policy, fiscal policy, financial markets, and the international order are tightly interconnected and increasingly constrain one another’s room for maneuver.
Why do financial markets remain surprisingly resilient despite high interest rates? What role do liquidity, fiscal policy, and the AI investment boom play in shaping risk-taking? And how robust is the international economic order in an increasingly multipolar world? These questions are at the core of the new episode of Thought Supply, a conversation between former governor of the Reserve Bank of India Raghuram G. Rajan and former WTO chief economist Ralph Ossa.
The observation that financial markets have remained remarkably stable despite one of the fastest tightening cycles in recent decades took center stage in the conversation. For Rajan, this stability calls for explanation. While monetary tightening has clearly raised policy rates, overall financial conditions have barely become more restrictive. A key reason, he argues, is the exceptionally high level of liquidity in the system – built up over many years of expansionary monetary policy and still exerting a strong influence.
Liquidity, expectations, and the role of the state
Rajan adds that many market participants continue to expect central banks to step in during times of stress. This implicit backstop reduces perceived risk and increases the willingness to take on larger positions, weakening the dampening effect of higher interest rates compared with earlier cycles. Fiscal policy also plays an important role. Persistently high public debt reflects an expansionary fiscal stance that continues to support aggregate demand.
Raghuram G. Rajan on Google Scholarbrowse
Why the next financial crisis may start with credit booms
Researchers
Raghuram G. Rajan is the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. From 2013 to 2016, he served as the 23rd Governor of the Reserve Bank of India, where he was widely credited with stabilizing the Indian economy during turbulent global conditions. Earlier in his career, he was Chief Economist and Director of Research at the International Monetary Fund. Professor Rajan has authored several acclaimed books, including Fault Lines, which won the Financial Times Business Book of the Year award, and The Third Pillar, a finalist for the same prize. His recent research has focused on sovereign debt, climate resilience, and liquidity dynamics in modern financial systems. He is a member of the American Academy of Arts and Sciences and currently chairs both the Group of Thirty and the Per Jacobsson Foundation. Rajan’s insights continue to shape the global conversation on financial regulation and inclusive growth.
UBS Foundation Professor of Economics
Ralph Ossa holds a UBS Foundation Professorship in Economics. From January 2023 until June 2025 he served as Chief Economist of the Word Trade Organization. His research focuses on international economics with a particular emphasis on questions of policy relevance. For example, he has explored the economics of trade wars and trade talks and estimated how much countries gain from international trade. For his project "Deep Integration Agreements", Ossa received an ERC Consolidator Grant from the European Research Council. He was chairman of the Department of Economics between 2019-2022 and co-editor of the Journal of International Economics between 2016-2022. Prior to moving to Zurich, he served on the faculty of the University of Chicago Booth School of Business. He holds a PhD in Economics from the London School of Economics.
Raghuram G. Rajan is the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. From 2013 to 2016, he served as the 23rd Governor of the Reserve Bank of India, where he was widely credited with stabilizing the Indian economy during turbulent global conditions. Earlier in his career, he was Chief Economist and Director of Research at the International Monetary Fund. Professor Rajan has authored several acclaimed books, including Fault Lines, which won the Financial Times Business Book of the Year award, and The Third Pillar, a finalist for the same prize. His recent research has focused on sovereign debt, climate resilience, and liquidity dynamics in modern financial systems. He is a member of the American Academy of Arts and Sciences and currently chairs both the Group of Thirty and the Per Jacobsson Foundation. Rajan’s insights continue to shape the global conversation on financial regulation and inclusive growth.
UBS Foundation Professor of Economics
Ralph Ossa holds a UBS Foundation Professorship in Economics. From January 2023 until June 2025 he served as Chief Economist of the Word Trade Organization. His research focuses on international economics with a particular emphasis on questions of policy relevance. For example, he has explored the economics of trade wars and trade talks and estimated how much countries gain from international trade. For his project "Deep Integration Agreements", Ossa received an ERC Consolidator Grant from the European Research Council. He was chairman of the Department of Economics between 2019-2022 and co-editor of the Journal of International Economics between 2016-2022. Prior to moving to Zurich, he served on the faculty of the University of Chicago Booth School of Business. He holds a PhD in Economics from the London School of Economics.