The Fed is Fighting Inflation: The First Two Months after the Fed Cut Rates Are Luckily for the Economy and for the Funds

The Fed cut the policy interest rate from 0.25 to 0.25 on Wednesday because of precedent. The decision was a surprise and it is good for the economy. At the start of the pandemic, the Fed rapidly slashed rates effectively to zero to keep the economy afloat — only to drastically change course and raise rates just as rapidly in 2022, when inflation spiked. With this week’s decision, the Fed has brought the federal funds rate, now in a target range of 4.75 percent to 5 percent, a step toward pre-pandemic norms.

Wednesday’s rate cut is the Fed’s first since 2020, but it won’t be the last. On average, members of the Fed’s rate-setting committee expect borrowing costs to drop by another half a percentage point this year and an additional full point next year. That’s a more rapid decline than committee members were projecting just three months ago.

The Fed has begun to wind down its fight against inflation. And for good reason. It was 2.5 percent in July, and that is still elevated, but it is only a third of the peak in 2022. The data shows deflation for much of the past two years. Even after this cut, the funds rate remains high enough to discourage some borrowing and spending, so the Fed is still fighting inflation by restraining demand.

Fed chairman Powell denied that the Fed was saying ‘Mission Accomplished’. “We’re encouraged by the progress we’ve made.”

At the same time, job growth has slowed and the unemployment rate has inched up to 4.2%, leaving Fed officials worried that high interest rates could become an unnecessary drag on the economy.

The pace of future rate cuts is uncertain at this time. One member of the committee, Michelle Bowman, wanted to proceed more cautiously on Wednesday, cutting the benchmark rate by just a quarter percentage point. Committee members are divided on how much further rates will need to fall next year.

While falling interest rates will help borrowers and potentially spur economic growth, they come with a cost for savers. The interest paid for online savings accounts and money market funds will likely decline.

The Fed’s First Cut: A Test of the Predictive Power of the Economic Correlations and Implications for the Labor Market

The timing of the Fed’s move is politically sensitive, coming less than seven weeks before a presidential election in which the strength of the economy is a key issue for voters. Powell has said repeatedly that he and his colleagues are not swayed by partisan politics.

Powell said their job is to support the economy on behalf of the American people. The American people will benefit a lot if we get it right. So we don’t put up any other filters. I can not tell you where you stop if you start doing that.

Unlike many other central banks, however, the Fed has a mandate for maximum employment along with price stability, and the decision for a larger cut also signals that it is taking seriously recent signs of slowing in the labor market. That’s appropriate. Over the past two months, data has indicated that the labor market was not as strong as the Fed thought. Where things stand is largely fine — the unemployment rate is 4.2 percent, and monthly payroll gains are only somewhat below their strong pace before the pandemic — but the trend is worrisome. The labor market is cooling off.