Introduction
In September, the Federal Reserve of the United States faced political pressure to lower interest rates. President Donald Trump has been insisting on this for months, even openly attacking Fed Chair Jerome Powell and other board members. This article explores the reasons behind Trump’s demands, the potential consequences of lowering rates, and why equity should be a primary concern.
Trump’s Demands for Lower Interest Rates
Trump’s primary motivation for demanding lower interest rates is to reduce the cost of government borrowing, which has surged due to short-term inflation expectations and concerns about the long-term sustainability of U.S. debt. However, this argument becomes complicated because, despite a marked decline in U.S. inflation from over 9% in 2022 to 2.9% currently, it is showing signs of rising again.
Risks of Lowering Interest Rates
Economists fear that lowering rates might reignite inflation, especially given the upward pressure on import prices due to tariffs. Although this effect hasn’t been significant so far, recent data suggests that the anticipated price increase is materializing. In these circumstances, lowering rates when markets expect more inflation could counterintuitively increase government borrowing costs, contrary to Trump’s intentions.
Historical Context and Equity
Despite the risks, lowering interest rates now isn’t a bad idea. This stance is not influenced by Trump’s opinions but rather by historical evidence and the need for equity.
Effectiveness of Raising Interest Rates
The anti-inflationary effect of raising interest rates isn’t as proven as commonly believed. Although recent disinflation is often attributed to the Federal Reserve’s monetary tightening, it contradicts historical patterns in monetary policy changes. Moreover, while it’s common to assume higher rates correspond to less inflation, it’s equally true that monetary policy operates with “long and variable lags,” suggesting interest rates may not be as closely tied to inflation as we’d like.
Research Findings
A recent study analyzed over 150,000 estimates of monetary policy effects from more than 400 studies. It found that after a 100 basis point increase in interest rates, price reductions over four years tend to be less than 0.15%. Between 2022 and 2023, the Fed raised rates by more than 500 basis points, and inflation fell from over 9% to around 3%. This suggests that at least part of the decline was due to the gradual disappearance of supply-side disturbances, such as falling energy prices and normalized global supply chains.
Equity Considerations
Lowering interest rates is also crucial for equity. Inflation disproportionately affects the poor, as lower-income households spend a larger portion of their income on essential goods like food, housing, and energy. However, rising interest rates have also negatively impacted lower-income households by increasing mortgage interest, credit card payments, auto loan delinquencies, and unemployment risk.
Impact on Income Inequality
A study by the Boston Fed using U.S. metropolitan areas’ Internal Revenue Service data found that an unexpected 25 basis point increase in interest rates raises income inequality by approximately 0.75% annually, on average. Over four years, this amounts to a 3% increase, primarily due to wage declines in the lower income decile. This demonstrates that a tightening Fed disproportionately harms low-wage workers.
Conclusion: Balancing Political Pressure and Vulnerable Groups
Given these reasons, lowering interest rates isn’t inherently bad. However, the debate has shifted from discussing the social costs of high rates to a political battle over the Fed’s independence. The danger lies in making a rate cut appear politically motivated, forcing the Fed into an unresolvable dilemma: either resist and risk exacerbating the plight of vulnerable groups or concede and signal that the central bank is susceptible to political pressures.
Key Questions and Answers
- Q: Why is Trump pushing for lower interest rates? A: Trump aims to reduce the cost of government borrowing, which has increased due to short-term inflation expectations and concerns about long-term debt sustainability.
- Q: What are the potential consequences of lowering interest rates? A: There’s a risk that lowering rates could reignite inflation, especially given upward pressure on import prices due to tariffs.
- Q: Why is equity a crucial consideration? A: Inflation disproportionately affects lower-income households, and rising interest rates exacerbate their financial burdens.
- Q: How does historical evidence support lowering interest rates? A: Recent studies show that the causal link between rate increases and reduced inflation is weaker and operates with more delay than commonly believed.
- Q: What is the impact of interest rate changes on income inequality? A: An unexpected increase in interest rates raises income inequality, primarily due to wage declines among lower-income workers.
