After spending the past two years trying to get inflation under control by raising interest rates, the Fed is inching toward cutting rates soon. This policy shift has ignited claims that the Fed is “being political” because in standard economic theory, cutting interest rates would stimulate the economy, making it easier for businesses to get loans, invest, and hire. Rather than a nonpartisan response to the shifting sands of the economy, the theory claims, the reason for the coming rate cuts is that the Fed and its chair, Jerome Powell, hate former President Donald Trump and want to keep Biden in office. It’s best to cut rates to boost the economy, improving voters’ opinion of Biden heading into the 2024 elections, the thinking goes.
Right now, most of the commentary saying the Fed is trying to boost Biden is coming from former Trump administration officials or other Republican-leaning commentators, but that doesn’t mean Democrats are immune from trying to politicize the Fed. Democratic Rep. Ro Khanna said the Fed needed to cut interest rates or Powell “may be the person most responsible for the possible return of Trump.”
Regardless of which party is haranguing the Fed, it’s important for Powell and the rest of the central bank not to look political. An apolitical independent central bank is a good thing for everyone because monetary policymaking free from political pressures will tend to result in a more stable economy. Setting interest rates should be about weighing costs and benefits for everyone, not engineering outcomes for a favored constituency. When people (usually those with a vested political interest) try to accuse the Fed of being biased, it erodes confidence. Don’t fall for these lies: The accusation that the Fed is being political or trying to boost Biden’s reelection chances has a few glaring problems.
Rate cuts, they just make sense
The first piece of the “Fed is trying to boost Biden” conspiracy theory is the idea that the central bank is suddenly reversing course on its inflation fight, as if Powell flipped on a dime as the election came into view. There’s an easy way to check this idea: Every quarter, the Fed releases its Summary of Economic Projections, which breaks down the Fed governors’ and board members’ projections for GDP, inflation, unemployment, and the appropriate federal funds interest rate. These forecasts are conditional, not a set-in-stone promise of what the Fed will do, but they provide a useful picture of the various members’ thinking about economic conditions at the time.
In the most recent summary, released in December, the Fed signaled that it planned to cut rates from 5.5% to 4.5% by the end of 2024. This was a change from the previous forecast, released in September, that estimated a 2024 year-end rate of 5%. The change was seen as a sign from the “Fed is political” camp that Powell et al. were laying the groundwork for more cuts, thereby boosting the economy for Biden. In fact, December’s 4.5% projection was the same rate projected in June’s Summary of Economic Projections — the September release was the aberrant one. Rather than suddenly reversing course, a sign of some sort of political motivation, the summary has consistently shown that the Fed members started projecting 2024 rate cuts in June 2022, roughly 1 years ago.
Second, there’s nothing special about recent revisions to the Fed’s interest-rate projections. Inflation is slowing more rapidly than expected, and the US job market, while solid, has shown early signs of shakiness, so it stands to reason that the Fed would react accordingly.
While the unemployment rate remains low, it has ticked up somewhat from its recent bottom, and other labor-market indicators, such as the hiring and quits rates, have weakened in recent months. Given the signs we’ve seen from the economy, the Fed’s adjustments to its forecast are pretty standard according to what’s known as the Taylor rule. The rule says that as projections for inflation decrease, the Fed’s forecast for its key interest rate should also go down. In the December Summary of Economic Projections, the Fed revised its projection for year-end 2024 core personal consumption expenditures inflation — the Fed’s favorite gauge for inflation — downward by a total of 0.7 points. According to the Taylor rule, the Fed should have lowered its projections for the federal funds interest rates as well — and it did. A rule of thumb would be to cut interest rates by half the total revision to core personal consumption expenditures, so another 0.35 points off the federal funds rate, which is exactly what it did. Rather than some political conspiracy, the rate-cut forecast is just rules-based common sense.
The third reason the political-Fed idea makes no sense is that history suggests Powell and the other members are operating well within precedent. Our nearby table shows where unemployment and core inflation were at the time of the Fed’s first interest rate cuts in the past. The unemployment rate was, on average, up 0.3 percentage points from its low, while core personal-consumption-expenditures inflation was running 2.5% at an annual rate in the three months leading up to the first cut. Where are we now? The headline unemployment rate stands at 3.7%, 0.3 points above its prior 12-month low, while core PCE inflation has climbed 2.16% at an annual rate over the past three months. That means core inflation is actually running somewhat below where it normally is when the Fed starts cutting. There’s nothing abnormal about these cuts.
Source: BI
