There They Go Again: Fed Cuts Rates When It Shouldn’t Have

Well, they didn’t listen to me – or at least most of them didn’t.

Beset by admittedly strong recession concerns but unable to acknowledge loose monetary policy won’t solve the problem, the Federal Reserve Open Market Committee reduced its interest rate again, less than two months after the previous cut (CNBC):

Following its two-day policy meeting, the central bank announced that it would take down its benchmark overnight lending rate to a target range of 1.75 percent to 2 percent. That comes nearly two months after the policy-making Federal Open Market Committee went ahead with its first cut in 11 years.

Major U.S. stock exchanges dropped after the decision was announced.

Note that markets fell afterwards. Why? Because they wanted even deeper cuts. The president echoed the madness.

President Donald Trump, who has called Fed policymakers “boneheads” for not cutting rates enough, tore into Wednesday’s decision, saying Chairman Jay Powell and his colleagues have “no ‘guts.” Trump says the Fed is risking U.S. competitiveness by keeping rates substantially higher than most of the rest of the developed world.

Keep in mind what “competitiveness” means here: Trump is mad at the damaging effects of his trade wars on the American economy. Combined with the end of the Keynesian sugar-high from an ill-conceived tax cut, this has led to serious economic blowback. Trump wants loose money to fix all of that …

… except that it can’t. Expansionary monetary policy can’t fix the higher prices that come from the tariffs (in fact, if it does anything, it will make them worse). It can’t address the fact that the supposedly supply-side tax cuts of 2017 were designed so poorly that no supply-side effect came from them (the tax code is more complex, and the expiration dates on tax reductions created too much uncertainty).

Meanwhile, excessively low interest rates exacerbate the asset bubble and distort risk signals, favoring more risky assets over safer ones. In case you don’t take my word for that, here’s Boston Fed President Eric Rosengren, one of the two FOMC members who opposed both rate cuts:

Additional monetary stimulus is not needed for an economy where labor markets are already tight, and risks further inflating the prices of risky assets and encouraging households and firms to take on too much leverage. While risks clearly exist related to trade and geopolitical concerns, lowering rates to address uncertainty is not costless.

Among the data points Rosengren cites to back him up is a bar chart tracking risky debts via a debt-to-earnings ratio. The ratio is higher than it was in 2007. Lowering rates will simply make that problem worse.

In short, the Fed has – once again – provided the wrong medicine to the American economy, the wisdom of its dissenters (Rosengren and KC President Ester George) notwithstanding. When the recession comes (and this week’s action will not slow it down), it will be much worse than it should be.