Introduction
PROVIDENCE – U.S. President Donald Trump openly desires lower interest rates, claiming that cheapening government borrowing would save billions in interest payments. However, the reality is more complex.
The Misconception of Low Interest Rates
Trump’s request for lower interest rates is not to combat inflation, unlike Turkish President Recep Tayyip Erdoğan. Erdoğan insisted that high interest rates cause inflation, leading the Turkish central bank to lower rates despite rising prices. The consequences were disastrous, with Turkish inflation surpassing 80% in 2022, the currency plummeting, and household savings evaporating. The country only avoided disaster when a conventional monetary policy was reinstated.
A Global Phenomenon
Turkey is not alone. Countries like Argentina, India, Venezuela, and Brazil have faced similar demands from populist leaders to lower interest rates. The question remains: why do these leaders persist despite historical evidence against them?
The True Cost of Borrowing
Interest rates for governments, businesses, and households depend not only on the official short-term interest rate set by the central bank but also on perceptions of borrowers’ solvency. A bank confident in a client’s financial situation and repayment ability will offer better terms, just as investors will provide favorable financing conditions if they trust a government’s fiscal trajectory, the country’s institutions, and its monetary authorities. This explains why emerging markets pay double-digit interest rates on their “risky” debt, even when global reference rates are low.
The Fed’s Influence
Lowering the official interest rate by the Fed does not guarantee cheaper credit across the economy, for consumers, businesses, or the government. If fiscal credibility deteriorates or inflation expectations rise, market rates may still increase despite the Fed’s rate cut. This is why populist governments fail to achieve economic miracles, as their policies eventually harm the economy.
Populist Policies and Their Short-term Appeal
Populist autocrats insist on lower interest rates because they prioritize short-term popularity over doing what’s right. Their policies may win elections immediately, but they weaken long-term economic growth. To avoid their supporters realizing the flaws in their policies too late, autocrats need low interest rates to mask the negative effects of their actions.
Case in Point: Protectionist Policies
Protectionist policies, such as tariffs on imports, reduce productivity and decrease long-term economic potential. However, imposing tariffs on foreigners to lower local taxes can be politically advantageous. Low interest rates provide temporary relief from these tariffs’ adverse effects, allowing consumers and businesses to easily take on debt without realizing future income reductions.
The Risks of Political Interference
Autocratic leaders must act swiftly, as slowing growth and rising prices due to tariffs will lead to electoral defeat. The populist government will try to pressure the Fed for rate cuts before economic slowdown becomes evident, hoping to conceal policy damage. However, this is a dangerous game. Low-cost credit can mask structural weaknesses, but prolonging this situation will eventually make the consequences more expensive.
The Importance of Fed Independence
Unlike Turkey, the U.S. still benefits from the Fed’s independence. A determined U.S. president might attempt to “colonize” the central bank with loyalists or inexperienced individuals, blurring the line between monetary and political authority. Market recognition of this lack of support would increase risk premiums and loan costs, exposing the vulnerability created by the U.S.’s fiscal trajectory.
Conclusion
With federal debt exceeding 100% of GDP and high deficits persisting, the U.S. relies heavily on market confidence in the Fed’s independence and credibility for manageable borrowing costs. Weakening this confidence could lead to sudden increases in borrowing costs, contrary to expectations, making public debt servicing more expensive rather than cheaper.
Key Questions and Answers
- Why do populist autocrats want low interest rates? They prioritize short-term popularity over sound economic policies, aiming to mask the negative effects of their actions without their supporters realizing the flaws in their policies too late.
- How do low interest rates impact the economy? While they may provide temporary relief, low interest rates do not guarantee cheaper credit across the economy. If fiscal credibility deteriorates or inflation expectations rise, market rates may still increase.
- What are the risks of political interference in monetary policy? Blurring the line between monetary and political authority can lead to increased risk premiums and loan costs, exposing vulnerabilities in borrowing costs.
