Introduction to the World of Economics and Politics
The US President, Donald Trump, has been vocal about his desire for lower interest rates. He believes that cheaper borrowing would lead to various benefits, including saving the government billions of dollars in debt-service payments. However, this desire for lower interest rates is not unique to Trump, as many populist-nationalist leaders have made similar demands in the past.
The Concept of Inflation and Interest Rates
Inflation in the US is currently running at 2.7%, which is above the Federal Reserve’s 2% target. This means that the Fed would not normally consider cutting interest rates. To understand why, it’s essential to grasp the concept of inflation and its relationship with interest rates. In simple terms, inflation refers to the rate at which prices for goods and services are rising. When inflation is high, it means that people’s money is not going as far as it used to, and the value of their savings is decreasing.
The Dangers of Populist Economic Policies
Some leaders, like Turkish President Recep Tayyip Erdoğan, have argued that high interest rates cause inflation. However, this approach has been disastrous in the past. In 2022, Turkey’s inflation peaked above 80%, the currency ended up in free fall, and households’ savings evaporated. This is just one example of how populist economic policies can have catastrophic consequences. Other countries, such as Argentina, India, Venezuela, and Brazil, have also been plagued by strongmen who insisted on low interest rates, with devastating results.
The Role of Central Banks in Setting Interest Rates
Central banks, like the Federal Reserve in the US, play a crucial role in setting interest rates. However, the problem is that borrowing costs for governments, firms, and households are not set simply by the central bank’s short-term policy rate. Instead, they reflect the perceived ability of borrowers to repay. If investors trust a government’s fiscal trajectory, its institutions, and its monetary authority, they will be willing to let it borrow cheaply. On the other hand, if they don’t trust the government, they will demand higher interest rates to compensate for the risk.
The Impact of Low Interest Rates on the Economy
Lowering the Fed’s policy rate does not guarantee cheaper credit across the economy. If fiscal credibility erodes or inflation expectations rise, market rates can move higher even as the Fed cuts the federal funds rate. This is why emerging markets face double-digit borrowing costs on their "risky" debt even when global policy rates are low. In other words, low interest rates cannot compensate for bad economic policies, such as tariffs. The US still benefits from an important safeguard: Fed independence, which means that the president cannot simply order the Fed to cut rates.
The Danger of Politicizing Monetary Policy
A determined US president could always try to "pack" the central bank with loyalists or people too inexperienced or too intimidated to resist political pressure. Once that happens, the line between monetary and political authority becomes blurred, and markets quickly realize that rate cuts are not supported by the data. At that point, risk premiums will rise, driving up borrowing costs. This would expose the vulnerability created by the trajectory of US fiscal policy, with federal debt above 100% of GDP and deficits projected to remain high.
Conclusion
In conclusion, the idea that prosperity can be engineered through low interest rates is a populist illusion. Low rates cannot compensate for bad economic policies like tariffs. The Fed’s credibility is too valuable and too important for global economic stability to be sacrificed on the altar of political convenience. As history has shown, populist economic policies can have disastrous consequences, and it’s essential to prioritize sound economic principles over short-term political gains. Ultimately, the US must protect the independence of the Federal Reserve and avoid politicizing monetary policy to ensure long-term economic growth and stability.
