How the Federal Reserve Can Cut Rates (Without Being Pushed Around)

Samuel Rines

Economics, United States

Better and clearer decision-making and communications are needed to avoid the appearance of a Fed bending to political pressure.

A 0.25 percent cut in the Federal funds rate is more of a token move than a meaningful one. But that is what the market expects, and the Federal Reserve has intimated. It will not matter. To be credible, the Fed needs to cut policy with precision and for a good reason, and that means dumping the useless 0.25 percent target bands and moving policy to a neutral stance. 

Worse still, such a placative move appears to either be caving to political pressure or to placate the whims of financial markets. Neither is an acceptable reason to slash interest rates. Both would do damage to the Fed’s credibility. It necessitates better explanation and nuance around the level of interest rates to avoid these appearances. 

With jobless claims plumbing to post-World War II lows and consumer sentiment riding decade highs, the timing is suspect from the beginning. Why now? 

Thus far, the reasoning from officials has been the consistent undershoot of its 2 percent inflation target and the need to reaffirm its commitment. But even that excuse has seen pushback from its officials. Monetary muscle memory remains from the inflation shocks of the late 1970s and early 1980s. No one wants a repeat blamed on them. 

The other oft-cited reasoning is the need to take out insurance against global economic ills and the potential spillover effects on the U.S. economy. This would set a precedent that the Fed is beholden to global developments, not simply its domestic mandate. That precedent could become difficult to walk backward and potentially place the Fed in awkward scenarios down the road. 

Because the reasoning for a rate cut is not straightforward (and the Fed’s own communication blunders have exacerbated the issue), there is the appearance that the Fed has been bullied into cutting rates. Whether or not that is the case, that is the appearance and appearances matter for credibility. President Trump has consistently tweeted his displeasure with Fed policy regarding both interest rates and the reduction of the balance sheet. Markets have seized on every opportunity to increase the expectations for easing. If the Fed does not carefully navigate the messaging surrounding a rate cut, it risks appearing subject to the whims of the market or a political entity. The Fed loses credibility regardless.