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The economist and New York Times Opinion columnist Paul Krugman makes the case for aggressive rate cuts by the Federal Reserve and argues that now is not the time for caution.
Below is a lightly edited transcript of the audio piece. To listen to this piece, click the play button below.
Paul Krugman: I’m Paul Krugman. I’m an opinion writer for The New York Times, also a professor at the City University of New York. I won third place in the Optimist Oratorical Contest in junior high school, and I also got a Nobel Prize.
Today, the Federal Reserve is more or less guaranteed to cut interest rates. We don’t know how big it’ll be, quarter point, half point, but it’s coming. It’s going to be a big deal.
The reason they’re going to do it is first and foremost that we’ve won the war on inflation. And we did it without a recession or a large rise in unemployment. The important thing now is to not fumble the landing. And so the question is going to be, “Will the Fed be pulling the plane’s nose up fast enough so that we do get a smooth landing on the runway?”
What I think the Fed should do is big rate cuts. The discussion has been between 25 and 50 basis points, where a basis point is a hundredth of a percentage point. That’s just the jargon people use. I would say it’s 50 for sure, but if you really look at it, I would say that even if they cut by 50, or half a percentage point, interest rates will be about 300 basis points higher than they were on the eve of the pandemic. And inflation is under control — what justifies those 300 extra basis points or three percentage points?
I would like to see the Fed cut by 200, 250, 300 basis points quite quickly, right away, with rhetoric that makes it clear that this is just the beginning.
The Federal Reserve is a slightly mysterious entity. It’s sort of part of the government and sort of not part of the government. And because it controls the amount of money in circulation, roughly speaking, it can also control short-term interest rates, which in turn tend to drive longer-term interest rates, which in turn drive things like whether people buy houses, whether businesses invest in new office buildings and so on. So the Fed is a tremendously powerful economic actor and one that can act quickly. It doesn’t require legislation. So the Fed is basically the short-term manager of the economy.
What has happened for the past several years is that the Fed was shocked by a big acceleration in inflation. And initially, they thought it would go away quickly, but they were wrong about that.
They responded by raising interest rates, and the reason you do that is to try to cool off the economy, reduce spending and reduce the demand for goods. It’s standard practice. They’ve done this before. Although this is the biggest rate hike we’ve seen since the early 1980s — they brought interest rates up by almost five percentage points from where they’d been when they started that process.
Now, inflation looks like it’s under control; the official numbers are on the order of two and a half percent. A lot of people, including the Fed, think that even that is really an exaggeration, that some of that is kind of a statistical illusion involving technical ways about the way they calculate housing costs and so on. So we basically beat inflation and the Fed needs to start cutting rates.
Can we at this point get a full soft landing where we have inflation under control without a recession? The answer is probably, but it’s iffy. We’ll find out, I guess, in retrospect. But you can certainly make the case that we’ve already waited too long to lower interest rates.
Jerome Powell is the chair of the Federal Reserve. It is a committee, but at least in recent decades, the Fed chair almost always gets what the Fed chair wants. And almost as important as the rate decision is what the Fed Chair says afterward in the news conference. They give you a number, but they also issue a statement, and people pore over that statement for tiny changes in wording from the last statement.
It’s like Kremlinology or something, right? Because you’re trying to infer what’s on the minds of the people making these decisions. So a lot depends on whether Powell says as clearly as Fed chairs ever say that we think inflation is beaten and we think that the economy is weakening.
If he says, “inflation appears to be well on track to target,” if he says it really forcefully now, that will be dovish. There are people out there who say, “I’m not convinced that we’ve really licked inflation, there’s still a last mile.” If Powell says anything that makes it sound as if he’s a last miler, that will be contractionary, that will tighten financial conditions. If he says pretty clearly “I don’t think that there’s a last mile, I think we’re there,” then that will loosen them. If he says, “we’re not concerned about the rise in unemployment” and just stops there, that would be hawkish, that would tend to raise longer-term interest rates. So it’s the words and the specificity.
Hardly anybody makes relevant economic decisions based on the three-month interest rate. What matters are things like the 10-year interest rate, the mortgage rate, all of which are driven not so much by what the Fed does on a given day, as by what people expect the Fed will be doing over the next several years.
And so the big question is, a Fed rate cut, whatever the size, if everybody perceives it as the beginning of a series of cuts and with a lot of cutting ahead, will it do a lot to lower the relevant interest rates? Mortgage rates will come way down if the Fed cuts and says this is just the beginning, even if the cut itself is not that big a deal.
What the Fed actually does is a signal of its future intentions. And so that’s why all eyes are going to be on the number, but the number mostly is important as a symbol. It’s telling us more about the Fed’s state of mind than about the specific cost of money.
One final point to make is that what the Fed does will have a political impact.
I think there’s no question that the Fed cutting rates is good news for Kamala Harris. It won’t really have much effect on the economy in time for the election. We’re practically on top of the election at this point. But it will be a signal that the Fed thinks that inflation has been defeated. And that’s good news for the candidate of the incumbent party, even if she’s not the incumbent president.
On the other hand, that’s not something that the Fed should take into account. The Fed is supposed to be doing its job. It’s supposed to be doing the best thing it can for the economy. The really political thing would be to hold off on doing the right thing because it might have a political impact that helped the party in power. We have a Fed that’s insulated from politics for a reason.
Now it’s kind of funny because the Fed doesn’t know anything that the rest of us don’t. They don’t actually have any inside information. Nonetheless, by cutting rates, they will kind of make the victory over inflation official, and that will have some political impact.
The post Paul Krugman on the Interest Rate Cut and What’s Next appeared first on New York Times.
