The Fed’s dreary choices

By Robert Samuelson

It’s a done deal. Almost everyone, or so it seems, believes the Federal Reserve will cut short-term interest rates next week when its main decision-making body meets. President Trump favors lower rates. So do many economists, including some fierce Trump critics. Similarly, Fed Chairman Jerome “Jay” Powell says the Fed wants to sustain the economic expansion. Finally, Wall Street loves lower rates, which prop up stock prices. That seems an unbeatable coalition.

Or is it?

On inspection, it’s unclear that the economy needs another jolt of cheap credit. Although the Fed has been raising rates since December 2015, they’re still low by historical standards. The Fed funds rate on overnight loans remains at a range of 2.25 % to 2.5%. With inflation close to 2%, “real” (inflation-adjusted) rates are near zero.

There are at least three plausible reasons for not cutting rates now.

(1) Although the economy has slowed from last year’s pace, it hasn’t dropped into a recession — typically defined as two consecutive quarters of declining output (gross domestic product).

In a July 18 interview with The Wall Street Journal’s Nick Timiraos, Eric Rosengren, head of the Boston Federal Reserve Bank, argued that recent economic news “has been positive.” He cited the strong job growth in June (224,000) plus retail sales, which have exceeded expectations. Rosengren said he wouldn’t make up his mind about cutting rates until the Fed’s July 30-31 meeting.

(2) Lower interest rates may fuel financial speculation, as investors borrow at low rates to buy assets (stocks, bonds, loans to “emerging market” countries) that send their prices to unrealistic and, ultimately, unsustainable levels.

In a 2014 paper, then-Fed Governor Jeremy Stein argued that there are times when policies to aid the overall economy clash with policies intended to limit financial speculation. Put plainly, cheap credit may be justified when unemployment is high but less so when it is low. In a recent email exchange, economist Stein — back at Harvard — said we might now be at one of those contradictory moments. Still, he added, it is hard “to believe that we are at risk of anything like the [2008-09 financial] crisis.”

(3) No matter how many times Powell and other Fed officials deny they are influenced by political pressures — Trump’s constant demands for rate cuts — it will be hard, perhaps impossible, for people to think that the Fed is truly independent.

For Powell, there is a dilemma. If he embraces Trump’s view that the economy needs more rate cuts, he will look like the president’s lackey, even if he genuinely believes that lower rates are the right policy. On the other hand, if Powell refuses to cut rates — because, say, he thinks the economy is doing well enough — he virtually ensures that there will be a political brawl with Trump.

All this is occurring against a highly charged backdrop about the degree to which the Fed is constrained by political pressures. Critics of the Fed argue that such a powerful agency should be subject to more public control.

In a lecture last week, Rosengren pushed back against this view by contending that the Fed is already subject to much public control. Congress sets the goals that should be pursued, he said, while the Fed decides — largely on technical grounds — how these goals ought to be reached. It’s an important debate, but the outcome may ultimately be determined by “facts on the ground,” as both Trump and Powell seek to enhance their political position.

(c) 2019, The Washington Post Writers Group