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 10-year-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.
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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, though he says he could back a more modest reduction if the economy weakens.
Lower rates would aid growth
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.
The moves also would raise the risk of financial asset bubbles forming and popping as investors move money from low yielding bonds to stocks, commercial real estate and other higher-yielding assets, Bostjancic says. The housing bubble, for example, led to the Great Recession of 2007-09.
Fed hasn’t ruled out rate cut
After lifting rates nine times since late 2015 and four times last year, Fed officials have repeatedly said they will be patient as they weigh future hikes. Fed policymakers abruptly scrapped a plan to boost rates twice this year after the stock market plunged late 2018 on the belief that forecast was too aggressive amid a slowing global economy. It’s now predicting no rate hikes this year as it waits and sees how the economy evolves.
In fact, Powell has declined to say whether the Fed’s next move is more likely to be a rate hike or cut.
“We don’t see a strong case for moving in either direction,” he said at a news conference Wednesday.
But the Fed would not be slicing rates just to supercharge the economy.
“The cases for cutting in my book are not ‘2% growth is too weak,’” Chicago Fed President Charles Evans told the Wall Street Journal in an interview published last week. Rather, he said, the Fed is worried about inflation that falls further.
Anemic inflation can lead to deflation, or falling prices, that prompt consumers to put off purchases, potentially causing an economic downturn.
“If (inflation) runs persistently below 2% for a sustained period that is something we would take into account in setting policy,” Powell said Wednesday. But he would not say if that would mean a rate decrease and said Fed officials suspect March’s unusually low inflation was due to temporary factors.
A rate cut also could be triggered by a market selloff or a “material growth slowdown,” Deutsche Bank says. Fed watchers lately have mused about the possibility of an “insurance” rate cut at some point that preemptively attempts to head off a slide in the economy. Some economists expect a quarter-point cut over the next year or so.
“We know why Mr. Trump is calling for a (far) lower rate,” Bostjancic says, citing the president’s desire for a booming economy as the 2020 election approaches.