December 11, 2019

The Economy Looks Solid, but the Fed Plans to Cut Rates Anyway. Here’s Why.

At times in the last several years, traditional measures of the American economy suggested that it was reaching full health and that interest rate increases might be justified to prevent inflation. But when the Fed’s policies diverge too much from those of its counterparts around the world, it causes the dollar to rise, financial conditions to seize up and overseas economies to slow, in turn endangering the United States economy.

This happened to varying degrees in 2013, when the Fed under Ben Bernanke sought to “taper” its quantitative easing program, and again in late 2015 and early 2016, when the Fed first raised interest rates under Janet Yellen, and again at the end of 2018 under Mr. Powell.

“Pursuing our domestic mandates in this new world requires that we understand the anticipated effects of these interconnections and incorporate them into our policy decision making,” Mr. Powell said in Paris. In practical terms, that can be viewed as part of the rationale for the imminent interest rate cut.

In his congressional testimony last week, Mr. Powell was uncommonly blunt in discussing the potential for the job market to get better, and the apparent failure of the Fed’s traditional models in which low unemployment is expected to fuel inflation.

None of this necessarily means that cutting interest rates right now, against the backdrop of a solid economy, is the right move. It could fuel financial bubbles that eventually put the expansion at risk, much as precautionary Fed interest rate increases in 1998, triggered by international turbulence, helped fuel a stock market bubble that popped in 2001.

But by owning up to the ways in which the intellectual framework behind the Fed’s push to raise rates over the last few years isn’t holding up to scrutiny, Mr. Powell is sending an important message: As long as he is running the show, the Fed will aim to react quickly to the world as it is, not as the models say it ought to be.

Article source: https://www.nytimes.com/2019/07/19/upshot/economy-fed-powell-rate-cuts-analysis.html?emc=rss&partner=rss

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