The U.S. economy added 224,000 jobs last month. Retail sales for both May and June came in unexpectedly high. Unemployment is enjoying its longest stretch at or below 4% in half a century. And the stock market has been hitting all-time highs.
So what is the Federal Reserve contemplating? An interest rate cut, likely to be announced Wednesday afternoon.
Most Fed watchers believe that the central bank will cut its funds rate, now hovering between 2.25% and 2.5%, by a quarter point, also known as 25 basis points. A small group — including President Donald Trump’s latest nominee for Fed governor — are pounding the table for a 50 basis point cut, which would take the rate below 2%. A rate cut of any size would be the first since the 2008 financial crisis.
Any cut now would be ill-timed and ill-advised. To the extent that the economy faces headwinds, it’s because of Trump’s trade and tariff policies, not because interest rates are too high. The economy is already on powerful medication, both fiscal and monetary.
In late 2017, Republicans in Washington enacted a deficit-financed $1.5 trillion tax cut. Not long thereafter, lawmakers from both parties agreed on a spending hike, with another in the works now. These actions have the government living beyond its means to the tune of $1 trillion a year.
OPPOSING VIEW: Interest rate reduction provides economic insurance
The federal funds rate, while up from nearly zero at the height of the 2009 recession, is still at a very stimulative level by historic standards. It hit 5.25% before the last recession and 6.5% in 2000.
To lower this already low rate, on top of the borrowing and spending, would make it look like central bank was taking its cues from investors keen to see the bull market continue. Worse yet, it would make the Fed look like it’s being browbeaten by Trump, who has loudly demanded Fed action to juice the economy leading into the 2020 presidential election.
Nothing in the economic data provides the rationale for the Fed to move from monetary stimulus to more monetary stimulus.
Nor is there much sense in it firing off ammunition it will need when an actual recession comes.
Indeed, the next recession could present a real problem. Deficits would surge, as they always do. But this time, they would surge up from already elevated levels, putting immense pressure on Washington to cut spending and raise taxes. That would depress an already reeling economy, creating a self-sustaining downward cycle.
The Fed is the institution that could step in. But it doesn’t have much to work with — roughly 2 points on the funds rate and the unsettling prospect of more “quantitative easing,” which involves inventing money to buy government Treasuries, housing bonds and such. If it cuts now, it will have even less to work with.
Moreover, very low interest rates have a distinct downside. They hurt savers, and investors in bonds such as pension funds, insurance companies and the Social Security trust fund.
The reality is this: Since the Great Recession, the Fed has been medicating the economy, with modest efforts to cut the dosage beginning in 2015. Then along comes Congress and the president with their own stimulative drugs that they are mainlining into the economy for full effect.
The Fed needs to take account of this — and not be so quick to act.
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