聯邦基金利率需要維持高水平嗎？

The Federal Reserve (Fed) left interest rates unchanged at today’s Federal Open Market Committee (FOMC) meeting. This is the third consecutive meeting in which it has done so. While Fed Chair Jerome Powell said that the Fed could raise rates again should the need arise, he was much less forceful on this point than at previous meetings. Chair Powell appears to agree with the market that the last hike in this cycle occurred this past July.

The conversation understandably turned to the prospect of rate cuts, and in particular to the potential timing of cuts in 2024. Chair Powell indicated that while rate cuts aren’t on the immediate horizon, there are many scenarios under which they might become appropriate in the not too distant future. We think the discussion of rate cuts is usefully framed as whether interest rates need to be so high. To preview our conclusion: should inflation move close to target and growth move close to trend, then interest rates should be close to neutral, rather than remain at the elevated level indicated in the Fed’s forecasts.

The economic environment

Inflation has declined substantially from its peak last year. Over the last three months the core Personal Consumption Expenditure (PCE) price index increased at a 2.3% annualized rate. A little over a year ago, the same measure was increasing at a 5.5% annualized rate. The dramatic decline in realized inflation reflects a wide range of improvements. Goods prices have declined as supply chains healed and goods demand normalized with respect to demand for services. Wage growth has slowed due to a steady loosening of the labor market. This has contributed to moderation in the pace of service-sector inflation. Monthly rent increases have fallen toward zero, due to slowing income growth as well as a pick up in the supply of multi-family housing. Moreover, there are reasons to expect the moderation in inflation will continue, especially in the services sector, as a continued loosening in the labor market will over time address one of the key remaining concerns of the Covid era.

In contrast to the steady decline in inflation over the past 18 months, the path for GDP growth has been considerably more volatile. Growth troughed in the middle of 2022 when the post-pandemic reopening seemed to have run its course. Subsequently, there was a scare in the spring of 2023 related to regional banks and tightening credit conditions. That gave way, in turn, to a few months of surprisingly fast growth over the summer of 2023, led by a pickup in consumption and supported by faster-than-expected job growth. Most recently, growth appears to have fallen back somewhat, and the latest data are consistent with trend-like growth through the end of 2023.

Where to next on economic growth? Pessimistic forecasters point to last spring’s regional bank scare as an antecedent of a sharper tightening in financial conditions. Optimistic forecasters cite the summer’s growth surge as evidence that elevated interest rates may not have the deleterious impacts many expected. The most likely outcome is somewhere in the middle. High interest rates and tight credit conditions create a headwind, especially for sectors that rely on long-term investment (e.g., housing and manufacturing). Consumption is also set to slow because prices remain elevated, as income growth has generally not kept up with inflation. At the same time, the slowdown will be attenuated by the generally stable foundations of the US economy. The vulnerabilities that led to previous recessions are notably absent from today’s economic landscape. For example, private debt is not at a concerning level, either for businesses or households.

How did interest rates get here?

Monetary policymakers aspire to be forward-looking and to set policy at the most appropriate level for the future environment. Their forecasts, however, inevitably put disproportionate weight on the starting point, and are therefore somewhat backward-looking in nature. This appears particularly true today, as the Fed forecasts interest rates will remain at the current level while the committee “proceeds carefully” with regard to any future moves. In assessing this forecast, it is instructive to ask: how did interest rates get to the current level of 5.25% to 5.5%? Obviously high interest rates were a response to the acute inflationary episode of 2021-2022, but why this level of interest rates, specifically?

At the June FOMC meeting in 2022, when the inflationary episode was already quite advanced and the Fed had accelerated its pace of hiking to 75 bps per meeting, Chair Powell said that a fed funds rate in the range of 3.5% to 4.0% would be sufficiently restrictive. The funds rate today is more than 1% higher than his guidance. Potentially, the difference could be due to updated estimates of neutral rates. However, Chair Powell has disparaged estimates of neutral rates as a useful benchmark for policy and the median longer-run policy rate projection is still below 3%. A more likely explanation is that the inflationary episode lasted a few months longer than expected, which caused the Fed to keep hiking for a few more meetings than expected.

A similar dynamic appears to have played out this past summer. At the March FOMC meeting this year, the Fed’s forecast was that interest rates would be 3% at the end of 2025. This was subsequently revised upward and in today’s forecast was 3.5%-3.75%. As before, the reason for the upward revision is more likely due to the path of recent economic data—in this case, the surge in growth through the third quarter—than it is due to changes in the estimates of appropriate policy for the next two years.

The implications are significant. Inflation has come down. The few extra months of elevated inflation were less a symptom of deeper inflationary forces and more a matter of timing. Similarly, growth has not sustained its pace from this past summer. The growth exuberance of just a few months ago now looks misplaced, or at least overdone. Therefore, two of the reasons that interest rates reached their current level may no longer be relevant. This casts some doubt on forecasts for interest rates to remain at current levels for any period of time.

Why do interest rates need to be elevated?

If the Fed were to start with a fresh perspective, it might arrive at a somewhat different forecast. In our view, the most likely environment for the coming two years is that inflation will move close to the Fed’s 2% target and economic growth will be somewhere around trend. Indeed, the Fed’s own forecasts suggest as much: the Summary of Economic Projections released today had core inflation at 2.2% and GDP growth at 1.8% in 2025. Given that economic environment, it is odd that the Fed also forecasts the appropriate policy rate will be close to 4% at the end of 2025. Just a few quarters ago, Chair Powell said that level of rates would be considered restrictive. Inflation close to target and growth around trend would normally call for policy to be close to neutral, rather than restrictive.

Some may object that the forecasted 2.3% inflation rate is not quite 2%, and that therefore tight policy would still be justified. We think this perspective is misguided because it ignores one of the key lessons from the pre-Covid era. Prior to Covid, the Fed (and other central banks) was concerned about an inflation rate that was a few tenths of a percentage point away from target. This sense of false precision led to a series of policy decisions that, with the benefit of hindsight, comprised a clear case of overengineering. A wiser course would have been to tolerate small deviations from the inflation target and save the available policy tools to respond to shocks, which inevitably occur. This harkens back to the opportunistic disinflation environment that Chairman Greenspan followed in the 1990s.

The US economy now appears to be headed toward a period of inflation close to the Fed’s target and growth close to trend growth. The Fed would be well served to ask whether rates need to remain elevated in such an environment. The answer, in our view, is that they do not.