Would a rate drop boost the economy?
But Fed leaves things unchanged anyway
After Trump advocates for cut, Fed leaves key interest rates unchanged
President Donald Trump tweeted this week that he wants the economy to “go up like a rocket,” ratcheting up his efforts to badger the Federal Reserve into slashing interest rates and resuming its crisis-era stimulus. Does he have a point? Inflation, or rising prices, has been persistently low, reducing the risk that it will climb to perilous levels if rates are trimmed. And some economists believe it’s more likely the Fed’s next move will be a rate cut rather than a hike.
The Fed, as expected, left its key interest rate unchanged Wednesday after a two-day meeting, and signaled that no rate hikes are likely in the coming months. It cited a solid economy but low inflation.
Here’s the rub: Trump is cheerleading for an excessively large rate cut for
the wrong reasons, economists say. And his proposal, if enacted, carries unpalatable risks for a relatively modest reward, even putting aside the potentially bigger hazard that the Fed would jeopardize the public’s confidence in its independence if it were to follow Trump’s advice.
How the economy is doing
First of all, the economy has been doing pretty darn well and doesn’t really need a booster shot. It grew 2.9% last year – matching a 13-year high – and 3.2% annualized in the first quarter despite the partial government shutdown.
True, the first-quarter figure was juiced by business stockpiling and a narrowing trade deficit – volatile factors that are likely to reverse in the current quarter, economists say. Both consumer spending and business investment – the economy’s meat and bones – were sluggish last quarter.
Consumption and business spending are likely to pick up, but economists generally expect growth to slow this year to about 2.2%, in line with its tepid average pace throughout the nearly 10year-old expansion. That’s largely because the Trump-led tax cuts and spending increases that goosed the economy last year are having a diminishing impact.
But Fed policymakers generally don’t slash rates just to make a good economy run faster – as if pressing a car’s accelerator – because it likely won’t quite work that way.
With unemployment near a half-century low at 3.8%, “Where would (businesses) find the additional workers” to churn out more products and services?, asks economist Kathy Bostjancic of Oxford Economics. Firms are already struggling to find enough employees.
Also, interest rates are already low, notes economist Paul Ashworth of Capital Economics. So borrowing costs are not exactly discouraging consumers and businesses from taking out loans and spending, he says.
Peter Morici, an economist at the University of Maryland and normally a supporter of Trump’s economic policies, called a 1% rate cut extreme.
On the margins, lower rates would spur more growth. Bostjancic estimates a percentage point rate cut this year would lift growth about half a percentage point the following year. But that hinges on companies being able to find enough workers, she says, far from a sure thing.
And the benefits of a rate cut would almost certainly be greater if unemployment were higher and wary consumers and businesses needed to be coaxed into more borrowing and spending, she says.
Trump’s advice also doesn’t account for an economy that has been hampered for years by weak growth in productivity, or output per worker, and an aging population that spells a slower-growing workforce. Lower interest rates won’t magically make those constraints vanish.
Meanwhile, a percentage-point cut in short-term rates and a revival of a bond-buying stimulus that shaves long-term rates both carry risks in return for modest rewards, Bostjancic and Ashworth say.
Sure, a core measure of annual inflation that strips out volatile food and energy costs dipped to 1.6% in March, moving further from the Fed’s 2% target. But a 1% rate cut and a renewal of bond purchases could well ramp up both inflation expectations and inflation to worrisome levels.
“You would potentially risk of overheating the economy,” Bostjancic says.