On Wednesday, the Federal Reserve announced it is leaving interest rates unchanged at around 5.3%, their highest level since 2001. Federal Reserve Chair Jerome Powell suggested that one or two rate cuts could come before the end of the year — but almost certainly not until fall. Wednesday’s decision to maintain current rates, though, was a mistake: The Fed should be cutting rates already. And every month it refuses to do so is a gift to Donald Trump.
Voters’ economic worries have long been among President Joe Biden’s biggest obstacles to re-election. Some of this discontent is rooted in partisanship: Republicans almost entirely flipped their views on the economy the moment Biden was inaugurated. Some of it can be traced back to the pandemic’s disruptions. But there’s no denying that a 20% increase in prices since Biden took office has played a role in those frustrations, even as wages have outpaced prices the last two years.
The Fed says it’s maintaining current interest rates to fight inflation. It might seem that that’s good for Biden. But that isn’t the case.
In the push and pull between fighting inflation and avoiding recession, other central bankers are beginning to lean toward the latter.
To be clear, the Fed’s theory has nothing to do with politics. (Trump has already promised he won’t reappoint Powell as chair.) Earlier Wednesday, the Consumer Price Index report put year-over-year inflation at 3.3%, slightly below expectations, and far below its 9.1% peak in June 2022, but still above where the Fed would like it. Combine that news with Friday’s jobs report, which showed job and wage growth accelerating in May, and it seems obvious why Powell and company are fearful of reversing course.
But a look beneath those top-line numbers shows this cautious reading is a mistake. The May jobs numbers may have been above expectations, but other data is less encouraging. First-quarter GDP growth was only 1.3% on an annual basis. The unemployment rate hit 4% for the first time in more than two years, and other metrics also show a softening labor market.
Also, Wednesday’s inflation number may be misleading. On a monthly basis, prices were flat for the first time in two years. Grocery prices were flat as well, and gas prices declined. Even auto insurance, which has jumped 20% over the past year, finally fell. The biggest factor in persistent inflation rates — housing — uses a metric that lags private-sector measures by months; the latter measures have shown housing prices declining more recently.
In the push and pull between fighting inflation and avoiding recession, other central bankers are beginning to lean toward the latter. The notoriously inflation-averse European Central Bank, as well as central banks in Canada, Switzerland and other countries, have cut rates. Yet the Fed is persisting.
The problem is that, by design, higher interest rates are not victimless. The very point is to put a brake on economic growth by making consumers reduce spending. But elevated rates increase the cost of mortgages, credit cards and car loans. These increased interest expenses are not reflected in the CPI, but they are absolutely on Americans’ minds when they complain about the rising cost of living.
The Fed’s delay is particularly frustrating because interest rates are a clumsy tool for fighting this bout of inflation.
Nor is this burden equally distributed. Just as rising prices disproportionately hurt poorer Americans, who spend more of their money on food and energy, higher interest rates are a bigger burden on those who can’t pay off credit card bills every month or who are looking to move out of a starter house.
The Fed’s delay is particularly frustrating because interest rates are a clumsy tool for fighting this bout of inflation. Higher rates can be useful when inflation is primarily a problem of too much consumer demand. But recent inflation has been driven far more by supply chain bottlenecks, other pandemic disruptions and corporations seeking bigger profits. (One study by Groundwork Collaborative found that “corporate profits drove 53 percent of inflation” in the middle six months of 2023.) Higher interest rates can still reduce inflation, but only in a roundabout fashion. And in the crucial housing sector, higher rates make homeowners more reluctant to take out a new mortgage to move, further raising prices amid the country’s broader housing shortage.
As The New York Times’ Peter Coy put it, “The blunt tool of high rates is coming down on the heads of the working class.” Pandemic-era savings have dried up, and Americans are cutting back, as evidenced by giant corporations like McDonald’s and Walmart cutting prices to woo back customers.
The last time Trump was in the White House, he often tried to undercut the Federal Reserve’s longstanding independence from the White House. That independence exists for a reason: to give credibility to the central bank’s economic targets. It’s ironic, then, that the Fed’s mistaken interest rate policy is unnecessarily risking the economy, raising the cost of living and buttressing a key voter concern that may help bring Trump back.