Fed Chair: Leaving Interest Rates Too High for Too Long Could Harm US Economic Growth

Fed Chair: Leaving Interest Rates Too High for Too Long Could Harm US Economic Growth

Federal Reserve Chair Jerome Powell speaks during a Senate Banking, Housing, and Urban Affairs Committee hearing on the semiannual monetary policy report to Congress at the U.S. Capitol on July 9, 2024. (Bonnie Cash/Getty Images)

Andrew Moran
Andrew Moran

7/9/2024

Updated: 7/9/2024

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Federal Reserve Chair Jerome Powell warned lawmakers on Capitol Hill that leaving interest rates too high for too long could threaten the U.S. economy.
Appearing before the Senate Banking Committee for his semiannual monetary policy report to Congress on July 9, Mr. Powell expressed concern that pivoting on monetary policy too early or too late “could unduly weaken economic activity and employment.”
“At the same time, in light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face,“ the Fed chief said in prepared remarks. ”Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
He reiterated the need for greater confidence before officials can reduce interest rates from the current range of between 5.25 percent and 5.5 percent.
“After a lack of progress toward our 2 percent inflation objective in the early part of this year, the most recent monthly readings have shown modest further progress,” Mr. Powell said. “More good data would strengthen our confidence that inflation is moving sustainably toward 2 percent.”
In the first three months of 2024, inflation came in higher than expected, leading to concerns that price pressures were reaccelerating. However, the April and May readings suggested that progress had been revived, fueling expectations of a rate cut soon.
Mr. Powell noted that “the U.S. economy continues to expand at a solid pace” despite the gross domestic product deceleration in the first quarter.
“Improving supply conditions have supported resilient demand and the strong performance of the U.S. economy over the past year,” he said.
“In the labor market, a broad set of indicators suggests that conditions have returned to about where they stood on the eve of the pandemic: strong, but not overheated.”
After the 1.4 percent gross domestic product (GDP) growth rate in the first quarter, the Atlanta Fed’s GDPNow Model estimates a 1.5 percent reading in the second quarter.
Mr. Powell will appear before the House Financial Services Committee on July 10.

Lawmakers Want Rate Cuts

Sen. Jack Reed (D-R.I.) echoed many of his Democrat colleagues’ concerns about maintaining higher rates for an extended period, telling Mr. Powell that he disapproves of the Fed’s delay in cutting the benchmark federal funds rate.
While the Fed chair conceded that it is unlikely that the next policy decision would be a rate hike, he repeated the need for more data before policymakers can agree on pivoting on the current monetary policy cycle.
Central bank officials have signaled that they will cut rates soon, but scores of Democrat lawmakers have been pushing the central bank to move faster.
Over the past several months, Democrats in Congress have penned letters to the Fed chief, making their positions clear that the longer the Fed keeps rates higher, the greater the risk of an economic downturn.
“The Fed’s monetary policy is not helping to reduce inflation. Indeed, it is driving up housing and auto insurance costs—two of the key drivers of inflation—threatening the health of the economy and risking a recession that could push thousands of American workers out of their jobs,” Sens. Elizabeth Warren (D-Mass.), John Hickenlooper (D-Colo.), and Jacky Rosen (D-Nev.) wrote in a June 10 letter.
“You have kept interest rates too high for too long: it is time to cut rates.”
Some Democrats have viewed interest rates through a political lens, asserting that leaving interest rates in a range of between 5.25 percent and 5.5 percent could cost President Joe Biden the election in November.
“Powell should cut interest rates now given most of [the] inflation was caused by supply shocks,” Rep. Ro Khanna (D-Calif.) said in a Dec. 27, 2023, X post. “If he doesn’t, he may be the person most responsible for the possible return of Trump.”
Mr. Powell has noted on multiple occasions that the 2024 presidential race is not a factor in the Fed’s decision-making process.
Following the May monetary policymaking meeting, the Fed chair told reporters that officials were “at peace” with keeping political considerations out of discussions in the run-up to the election.
“If you go down the road, where do you stop? And so we’re not on that road,” Mr. Powell said. “We’re on the road where we’re serving all the American people, and making our decisions based on the data and how those data affect the outlook and the balance of risks.”
The futures market is penciling in the first rate cut at the September meeting, according to the CME FedWatch Tool.

Basel III Endgame

Banking regulation, particularly the Basel III endgame proposal, was another top issue for Republican lawmakers.
Since the collapse of Silicon Valley Bank and Signature Bank in March 2023, considerable focus has been placed on the sweeping blueprint for stricter bank capital requirements. The framework would apply to banks with more than $100 billion in assets, changing how some of the largest financial institutions manage their capital.
Republican senators, including Sen. Tim Scott (R-S.C.), have expressed caution that the regulatory proposal would be another example of overregulating and forcing more capital to sit on the sidelines.
“Basel III capital requirements are like taking your star quarterback and telling him to sit on the sidelines because he just might get injured during the season,” Mr. Scott said. “It’s just plain ridiculous.”
Republicans urged Mr. Powell to bring transparency to further rulemaking for the banking system.
“The stakes are high. And that is why we have to get this right,” Mr. Scott said.
The Fed head stopped short on when the Basel III plan would be finalized but estimated that it would be another year before there is a final determination on the proposal.
In media appearances, press conferences, and congressional testimony, Mr. Powell has hinted that the original capital proposal could be revised and said he would seek “broad support” for the final model from voices inside and outside the central bank.
Wall Street executives, such as JPMorgan Chase CEO Jamie Dimon, have warned that raising capital requirements would “hamper American banks.”
“The Basel III endgame has been 10 years in the making, and it still has not been completed,” Mr. Dimon wrote in his annual report to shareholders in April. “In my view, many of the rules are flawed and poorly calibrated. If the Basel III endgame were implemented in its current form, it would hamper American banks.”
Ms. Warren has accused Mr. Powell of affording the banking sector too much influence on regulations, expressing concern over language that the banks will regulate themselves.
The Fed chief denied the accusation.
“You let them do whatever they want, but you don’t work for the giant banks. You work for the American people. I urge you to do your job,” Ms. Warren said.
In a June 17 letter, the senator from Massachusetts, who is seeking a third term, asserted that Mr. Powell was “advocating for slashing in half” the increase in capital requirements.
“I am disappointed by press reports indicating that you are personally intervening—after numerous meetings with big bank CEOs—to delay and water down the Basel III capital rules,” she said.
“It now appears that you are directly doing the bank industry’s bidding, rewarding them for their extensive personal lobbying of you.”

Inflation Ahead

Following Mr. Powell’s two-day appearance on Capitol Hill, the Federal Reserve will pay close attention to the consumer price index (CPI) and the producer price index (PPI) data.
After two straight months of easing inflation, the June CPI report is expected to show a slowdown to 3.1 percent, according to the Cleveland Fed’s Inflation Nowcasting model. Core inflation, which excludes the volatile food and energy components, is projected to ease to 3.3 percent.
The market consensus estimate shows that producer prices—the prices for goods and services paid by businesses—are anticipated to rise by 0.1 percent month over month and increase to 2.3 percent year over year. Core PPI is expected to climb by 0.2 percent monthly and 2.5 percent year-over-year.
The financial markets hope for softer-than-expected inflation prints to nudge the Fed to pull the trigger on its first quarter-point rate cut.
Economists contend that a blend of easing inflation pressures and weakness in the U.S. economy could be enough to allow the Fed to cut interest rates.
“The Fed doesn’t want to cause a recession if it doesn’t have to and if the data allows it to start making monetary policy slightly less restrictive, we think the Fed will take that opportunity, potentially as soon as September,” James Knightley, chief international economist at ING, wrote in a report.
The challenge for the institution has been sticky and stubborn inflation, whether in shelter or services. Although the upcoming CPI is seen as falling, the Cleveland Fed’s model asserts that it could rise to 3.2 percent.
The Atlanta Fed’s sticky-price CPI—a weighted basket of items that change price relatively slowly—is up by 4.3 percent year-over-year.
U.S. households think that the Fed will be unable to restore its 2 percent inflation target.
According to the New York Fed’s latest Survey of Consumer Expectations, households believe that the one-year inflation outlook is 3 percent. The three-year horizon rose by 0.1 percentage points to 2.9 percent, while the five-year horizon slipped by 0.2 percentage points to 2.8 percent.
As for the broader economy, evidence in recent weeks suggests weakness in the national economy.
Annualized consumer spending growth is likely to slow to 1.5 percent in the first half of 2024 from the 3.2 percent growth rate in the second half of 2023, according to Mr. Knightley.
The unemployment rate ticked up above 4 percent in June, initial jobless claims are trending higher, and tepid business hiring surveys might signal a weakening labor market.
“GDP growth will remain lacklustre this year but, as the shift in monetary policy begins to boost spending, growth should reaccelerate from 2025,” Jennifer McKeown, chief global economist at Capital Economics, wrote in a report.
“Slower wage growth and strong productivity growth will bear down on core inflation, prompting the Fed to cut rates in September. But the upcoming election adds to uncertainty.”
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Andrew Moran has been writing about business, economics, and finance for more than a decade. He is the author of "The War on Cash."

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