Fed official's U-turn makes strong case for September rate cut
Minneapolis Fed President Neel Kashkari has had a change of heart about interest rate cuts, arguing that the “balance of risk has shifted” in the economy.
In a recent interview with The Wall Street Journal, Kashkari said, “The debate about potentially cutting rates in September is an important one to have.”
That’s a major shift from June when Kashkari said the central bank should probably postpone a rate cut until the end of the year. The apparent U-turn came after the government’s latest nonfarm payrolls report showed a spike in the unemployment rate.
Now, many economists are sounding the alarm on a possible recession.
“If we were not seeing evidence that the labor market was weakening, if the unemployment rate was still in the 3.7% to 3.8% range, I don’t think I would be even debating, ‘Hey, is now the time to cut rates?’” Kashkari said.
To Kashkari’s point, the unemployment rate jumped to 4.3% in July from just 3.7% at the start of the year. Although unemployment remains fairly low by historical standards, it’s the magnitude of change that’s sounding the alarm bells.
Like most central bankers, Kashkari doesn’t think jumbo-sized rate cuts are warranted—not until the Fed sees “some quicker deterioration in the labor market.” In his view, a 0.25% reduction would be the most appropriate.
While this may seem rational, many economists say it highlights the current Fed administration’s reactionary approach to monetary policy. And that’s the biggest problem.
“Play-by-play commentator”
Rather than be forward-looking, Jerome Powell’s Fed is overly data-dependent, according to Queens’ College president Mohamed El-Erian. The end result is a central bank that’s constantly behind the curve, making the right decisions at the wrong time.
El-Erian called the central bank a “play-by-play commentator” that lacks the flexibility to make policy changes when they’re needed most.
The economist believes the Fed should have abandoned its 2% inflation target a long time ago and shifted its focus to the labor market. Now, it’s clear that the economy is “slowing faster than most expect,” El-Erian said.
Other economists say the Fed’s inflation-fighting mandate may have been doomed from the start. Unlike in decades past, high interest rates can only go so far in bringing inflation back toward the Fed’s 2% target.
Richard Koo, the chief economist at Nomura Research Institute, said that if interest rates are raised to fight inflation, “you have to remove the $3.2 trillion” in excess reserves sloshing around the banking system first.
“So much is on interest rates, and interest rates will have to go much higher to get the same effect it did have before excess reserves were at this magnitude,” Koo explained.
That’s why several economists, including Harvard’s Jason Furman and Moody’s Mark Zandi, believe the Fed should have quietly abandoned its 2% target and focused on price stability closer to 3%.