Federal Reserve should assert parental authority

Congress established the Federal Reserve to manage our money with near-parental authority, and it’s high time for the institution to exercise that authority.

Just about everyone, save creditors, likes lower interest rates.

Stock prices get a boost, business startups have an easier time attracting investors, homebuilders greet more eager buyers, and carrying a credit card balance gets less burdensome.

The occupant of the Oval Office is usually the most enthusiastic advocate, and President Trump is particularly forceful.

He has appointed White House staffer Stephen Miran to the Fed board and wants to oust Governor Lisa Cook, even though she is one of its more dovish members.

Unfortunately, the president and Congress are making the Fed’s job virtually undoable.

The Fed’s primary tool is its ability to set the federal funds rate, the rate banks pay one another for overnight loans. To lower the federal funds rate, it prints money to buy short-term government bonds. Additional liquidity should pull down the 10-year Treasury rate, which powerfully influences the rates charged for business and consumer loans.

Nowadays, the Fed’s potency is more limited. Since Sept. 18, 2024, the Fed has cut the fed funds rate by 1.25%, but the 10-year Treasury rate has risen from 3.7% to about 4%.

At a time when the economy is growing well — second-quarter growth in gross domestic product was 3.8%, and the forecasters expect another good print for the third quarter — the federal government deficit should be falling. Yet it remains stubborn at about $1.8 trillion and more than 6% of GDP.

Simply, the president and Congress aren’t inclined to curb runaway spending on health care and Social Security, and new government borrowing at that scale makes it difficult for the Fed to pull down the 10-year Treasury rate.

The artificial intelligence boom is instigating new investment spending we didn’t have two years ago. That’s about 1.3% of GDP, and much of that is borrowed.

Japan’s new prime minister is a firm advocate of stimulative fiscal policies, and European Union members are borrowing more to spend on defense.

Excessive borrowing is at the center of the continuing political crisis in France.

The bottom line is that Western governments are printing and selling bonds at a torrid pace. All that supply, along with a breakneck buildout for AI, is driving up long-term rates in a manner that manipulating the U.S. overnight bank borrowing rate can’t much affect.

U.S. inflation has been near or above 3% for four years. Surveys of households by the Conference Board, the New York Federal Reserve Bank and the University of Michigan indicate that the general public expects that level of inflation to continue.

Like all other presidents, Mr. Trump has several motivations for nagging the Federal Reserve to lower interest rates. First, lower rates would reduce the interest paid by the federal government on outstanding debt, which is now more than $1.2 trillion annually and more than we spend on defense.

However, lowering interest rates won’t do much good if Congress just turns around and does things like make permanent the COVID-19 health insurance subsidies and enhancements to Medicaid. Congressional Democrats are demanding that, and Republicans likely will have to accede to get a budget passed.

Second, lower rates could create a more robust labor market, but the biggest threats to job creation are Mr. Trump’s immigration and tariff policies. Without immigration, the workforce will expand at only about 24,000 jobs monthly. With the economy near full employment, it has created 27,000 jobs monthly since May.

In turn, Mr. Trump’s spending, tariffs and deportations are making international investors nervous about the long-term outlook for the dollar.

Gold has rocketed past $4,000 an ounce. Investors are rushing into the precious metal to hedge against Washington and other Western governments simply running the printing presses to finance the escalating costs for health care, Social Security and debt service. The resulting inflation would debase the real value of the dollar, other currencies and government bonds.

A better hedge would be an S&P 500 index fund, as corporate profits also will rise with inflation.

Indeed, the only way the Fed can lower the 10-year Treasury rate and reduce the burden of debt service on federal finances is to start buying long bonds again, as it did during the recessions instigated by the 2008 financial crisis and COVID-19 shutdowns.

Paradoxically, Treasury Secretary Scott Bessent has criticized such quantitative easing. Still, it helped boost the crisis-fighting strategies of two of Trump 2.0’s Republican predecessors: President George W. Bush and, oh yes, President Trump 1.0.

Federal Reserve policymakers appear a bit flummoxed about what to do next. Like stern parents, they should tell the children at the White House and on Capitol Hill, “You’ve overspent your allowance, and we have no intention of recklessly printing money to bail you out.”

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