Introduction to the Debate
President Donald Trump has been vocal about his belief that Federal Reserve Chairman Jerome Powell is behind the curve and should lower interest rates immediately. This stance has been met with criticism from various quarters. However, a closer examination of the inflation record since Trump’s inauguration reveals that his argument might have some merit.
Understanding the Federal Reserve’s Mandate
The Federal Reserve has a dual mandate: to maintain stable prices and encourage low unemployment. Since the 1970s, when it successfully addressed stagflation, the Fed has sought to balance these goals by setting a clear inflation target and adjusting interest rates in response to economic trends. The target has been roughly a 2% annual rise in core prices, excluding volatile food and energy segments.
The Current Inflation Record
The common wisdom suggests that the core inflation rate remains above 2%, justifying Powell’s stance that interest rates are at the right level. However, this analysis overlooks a crucial point: inflation has been trending downward since Trump took office. The annualized increase in the Consumer Price Index’s core index over the last five months is about 1.9%, while the core price index in the Personal Consumption Expenditures database has risen by a mere 1.2% annualized rate over the last three months.
Removing Biden-Era Inflation
If we remove the higher inflation rates from the Biden administration, it becomes clear that Trump’s policies have been effective in cutting inflation. This opens the way for lower interest rates, which is what Trump has been calling for.
Determining the Appropriate Interest Rate Cut
The question remains how much interest rates should be cut. This depends on the "real rate of return" that the Fed aims to provide investors above the inflation rate. Historically, this premium has been around 2.5%. However, since the Great Recession, the Fed has run a loose monetary policy, with near-zero short-term interest rates, meaning investors have lost money when saving.
Post-Pandemic Monetary Policy
The post-pandemic inflationary spurt led Powell to reinstate a positive real rate of return. However, this rate has rarely reached the historic 2.5% level. Applying the current preferred real rate to the Trump-era inflation record suggests that the Fed should cut rates now. With the current Fed target between 4.25 and 4.5%, and an effective rate of 4.33%, a cut to between 3.5 and 3.75% would be appropriate, given the 1.9% annual core inflation rate.
Economic Implications of a Rate Cut
A cut of this magnitude would have significant effects on the economy. Bond prices would rise, and stock prices would likely increase in response to Fed rate cuts. Mortgage rates would come down, making buying a home more affordable. This is why Trump and his team are frustrated with Powell’s hesitation, seeing it as holding back economic growth.
Powell’s Caution and Tariff Policy
Powell might argue that uncertainty over Trump’s tariff policy justifies his caution. However, the record suggests that tariffs have not led to higher core inflation rates for goods excluding food and energy, which are currently running at a 1% annualized rate.
Conclusion
The Federal Reserve is legally independent, so Trump can only advocate for his position publicly. Soon, either inflation will pick up, justifying Powell’s caution, or the Fed will recognize the data and give Trump the interest rate cuts his record has merited. The decision will significantly impact the economy and will be a critical moment in the interplay between monetary policy and political leadership.
