Fed Chairman Powell Is too eager to cut interest rates

Federal Reserve policymakers appear poised to cut interest rates three times this year — and sadly, this could boost inflation and slow longer-term economic growth.

The Fed’s stance on interest rates is only half of macroeconomic policy. The federal deficit remains quite inflationary.

The Congressional Budget Office projects the deficit will be 5.3% of gross domestic product this year. That’s up from 4.6% in 2019, the last year prior to the pandemic and elevated inflation.

In 2025, the deficit will jump to 6.1%, and the difference from 2019 will pump the demand for goods and services by half a trillion dollars.

Those estimates are based on the federal policies remaining unchanged, but President Biden and former President Donald Trump are hardly the souls of fiscal restraint.

Mr. Biden wants to boost federal assistance for pre-K education, child care and tax credits for working families.

Democrats need to win the House and hold the Senate to finance those with new taxes, but the Senate electoral map heavily favors the GOP. Consequently, additions to the social safety net in Mr. Biden's second term will not likely be fully funded by added revenue.

Mr. Trump wants to cut corporate taxes and fund that by raising tariffs, but the lesson from his first term is that tariffs never raise as much revenue as advertised. Too many products from China can’t be quickly sourced elsewhere. Consequently, we can count on many exceptions and lost revenue.

Fed Chairman Jerome Powell has repeatedly said he won’t lower interest rates until he is confident that the inflation rate "is moving sustainably down toward 2%.” But how can he ever be certain until we hit 2%?

In 2021, the Fed and the White House expressed confidence that inflation was transitory, but that proved false. The economists who advise them and those who ply their trade at banks and other private shops have been terrible at forecasting the post-COVID economy.

Chairman Paul Volcker jacked the federal funds rate to 17.6% in 1980, then pulled back to deal with a recession but ultimately had to boost it to 19.1% as inflation surged again.

An International Monetary Fund study of 100 efforts to combat inflation across 40 countries indicates longer-term growth performance is much better when central banks refrain from cutting interest rates too soon.

Given these experiences and the trials of the Volcker period, which best parallels what we have just been through, it would be better to keep interest rates high for a bit longer than risk cutting those prematurely.

The recent surge in immigration has significantly increased the labor supply and has not much depressed wages. Instead, immigrants bring skills that are in short supply, complementing domestic workers and making them more productive.

Some immigrants fill jobs native-born Americans would prefer not to do, and overall, more immigrants give the Fed more flexibility to delay interest rate cuts.

Also, more immigrants earning a paycheck add to demand in the economy and require more public services. For example, their children attend public schools. Those waiting for work permits require shelter and subsistence. These considerations would also indicate delaying interest rate cuts is more appropriate than pushing ahead.

The president is making historic investments in manufacturing — for electric vehicles and batteries and semiconductors — and these are fueling a boom in factory construction that challenges our capacity to build.

Lowering interest rates would likely create added impetus and fuel inflation in the construction sector.

Artificial intelligence is creating a boom in technology investments through the chain, from chips designed by Nvidia and its competitors to cloud computing and software applications from Microsoft and Google.

These developments are creating capital market conditions quite opposite to those that prevailed in the years between the global financial crisis of 2007-2009 and the pandemic shutdowns when interest rates were kept quite low.

As of this writing, the 10-year Treasury rate, which provides a benchmark for home and commercial mortgages and corporate borrowing and bonds throughout the economy, is about 4.25%, implying a real interest rate in excess of about 1.5%. This compares with average nominal and inflation-adjusted rates of 2.4% and 0.2% from 2008 to 2013.

Before Mr. Biden’s factory boom and privately inspired investments in AI, capital was cheap, and a lot was lent to prop up firms with sub-investment-grade bond ratings.

Now, those businesses are scurrying to refinance debt in a higher interest rate environment. And capital is being redirected to new battery and semiconductor plants and cloud and software investments that could genuinely improve the productivity of the U.S. economy and living standards.

Lowering interest rates would finance both the failing firms and those that promise a brighter future and overheat the economy.

Interest rates, at least for now, are best left where they are.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.