Pop the Champagne for the Fed Rate Cut and a Soft Landing Ahead
Former President Donald Trump has criticized the recent Federal Reserve interest rate cut as politically motivated, but former Chair of the Council of Economic Advisers argues it’s exactly what the economy needs.
As Vice President Kamala Harris and Trump engage in heated debates about economic policy on the campaign trail, a critical decision affecting jobs, inflation, and mortgage rates was made in Washington. The Federal Reserve cut its benchmark borrowing rate by half a percentage point, marking the first easing of monetary policy in four years.
Over the past two years, aggressive rate hikes by the Fed have successfully cooled the economy, reducing its preferred inflation measure from a peak of 7.1% in June 2022 to 2.5% last month. This allowed the Fed to ease up on its tight monetary policy.
While the Fed isn’t infallible, its track record in predictions and policy-making is strong, thanks in part to its nonpartisan tradition. For instance, Fed Chair Jerome Powell was appointed by Trump and reappointed by President Biden, showcasing its commitment to independent economic stewardship.
Trump’s assertions that the rate cut is political are contested by many Republicans and market professionals alike. The impact of this cut will take time to manifest in job openings or grocery prices, likely having little influence on the upcoming election.
The Fed’s independence allowed it to implement rate hikes to combat inflation, a decision that was not universally popular. Families faced higher mortgage rates, and businesses struggled with borrowing costs. However, the strategy of short-term pain for long-term gain has begun to yield results, with inflation now at 2.5%, nearing the Fed’s 2% target.
The aggressive actions taken by the Fed were essential in preventing a repeat of the wage-price spiral seen in the 1970s and in aligning job openings with available workers. Additional factors, such as improved supply chains and declining oil prices, also contributed.
While the unemployment rate has risen slightly from a low of 3.4% in April 2023 to 4.2% in August, it remains low compared to historical standards. The economy has created more jobs than anticipated post-COVID, aided by both recovery and immigration. The Fed’s rate cut aims to keep unemployment from rising further.
The Fed reduced the federal funds rate from 5.3% to about 4.8%. Anticipation of this cut has already led to a drop in mortgage rates, from a high of 7.2% in October 2023 to 6.2% in mid-September.
Some economists argued against the rate cut until inflation hit the 2% mark, but there are several reasons this would have been counterproductive. First, monetary policy operates with a delay, necessitating timely action. Second, the Fed must balance its dual mandate of controlling inflation while maintaining low unemployment. Finally, the significant decline in inflation means the Fed can afford to lower rates without jeopardizing stability.
Critics who argue for an immediate return to pre-pandemic rates overlook the risks of unchecked demand and rising inflation. While a quarter-point cut might have been preferable, the decision for a half-point reduction still positions rates in a contractionary stance.
Moreover, the Fed’s current rate setting not only affects today’s economy but also sets expectations for future cuts. These expectations are crucial as the Fed navigates the complexities of inflation and economic stability.
In essence, while the Fed’s work is far from complete, today’s cut felt like a toast to progress, with hopes for a soft landing—where inflation returns to 2% without triggering a recession—now appearing within reach.
Jason Furman, a former top economic adviser to President Barack Obama, teaches at Harvard and is a senior fellow at the Peterson Institute for International Economics.