Powell shouldn’t yield to Trump’s bullying

OPINION:

Federal Reserve Chair Jerome Powell shouldn’t yield to President Trump’s bullying to lower interest rates. Interest rates are close to where they should land after the tariff turmoil subsides.

In the meantime, the Fed doesn’t know enough about where the economy, inflation and unemployment are headed to deviate much from that golden mean.

The Fed influences but doesn’t set interest rates. It sets the federal funds rate, the overnight rate banks charge one another when lending reserves they keep to back up their balance sheets.

The Fed maintains its target rate, currently 4.25% to 4.5%, through Open Market Operations. Essentially, it prints money to buy short-term Treasury securities to keep that rate on mark. That influences the supply of money in circulation and the structure of market-determined interest rates for Treasury securities of varying maturities up to 30-year bonds.

The 10-year Treasury is key; it tends to be the benchmark for mortgages, other consumer and business loans, and corporate bonds.

As of this writing, the 10-year Treasury rate is about 4.2%.

That’s not very different from the federal funds rate now, but it’s generally higher when the economy is healthy, growing and not rattled by erratic presidential pronouncements about tariffs. That margin reflects anticipated inflation and lost opportunities to invest money for greater returns over the next 10 years.

The 10-year Treasury rate doesn’t move in lockstep with the federal funds rate.

From September to December, the Fed lowered the target federal funds rate by 1 percentage point. Still, investor fears about the swelling federal budget deficits pushed up the 10-year Treasury rate nearly a percentage point.

By historical standards, the 10-year Treasury rate isn’t too high.

During the period between the global financial crisis and COVID-19, the surge of inexpensive imported goods from China and elsewhere in Asia, a growing share of immigrants in the U.S. population and a downshift in consumer spending as households rebuilt balance sheets damaged by the crisis all kept inflation and interest rates abnormally low.

From 2009 to 2021, inflation was often less than 2% and the 10-Treasury rate averaged 2.3%.

Before the Trump tariffs kicked in, inflation was falling from its surge after the pandemic emergency. However, with the process of reshoring some manufacturing and realigning supply chains in response to Mr. Trump’s tariffs, we should expect an attainable pace of inflation that isn’t inclined to accelerate at about 2.5%.

Economists generally peg the attainable pace of gross domestic product growth that won’t accelerate inflation at about 2%. Summing expected inflation and growth, a 10-year Treasury rate of 4.5% would be about right.

In the four decades before the global financial crisis, the economy endured oil crises, President Nixon’s pressure on Fed Chair Arthur Burns to keep interest rates low, resulting in multiple surges in inflation, Fed Chairman Paul Volcker’s reining in those excesses, and then a period of stability that economists call the Great Moderation.

From 1968 to 2008, inflation averaged about 4%, GDP growth was nearly 3% and the average 10-year Treasury rate was 7.4%, a bit higher than the sum of the two.

For our times, with expected inflation and growth of about 2.5% and 2.0%, Fed policy, as indicated by a 4.2% 10-year Treasury rate, is about where it should be in long-term equilibrium.

Of course, we live in the short run. Prices or unemployment rise with shocks to the economy.

Tariffs, robots and artificial intelligence displacing many jobs threaten to boost one or both, and at this juncture, we simply don’t know in which direction the duck will fly and where Mr. Powell should aim his shotgun.

The most recent jobs report was not encouraging.

In July, the economy added 73,000 new positions, but too many were in health care and social services, which depend heavily on government financing. Private-sector hiring elsewhere is terribly slow.

Likewise, the most recent readings for the Personal Consumption Expenditures Price Index show inflation at 2.6%, well above the Fed’s 2% target, and tariff-sensitive categories such as furniture, toys and clothing are surging.

Some retailers — most notably, behemoth Amazon — are using all the buzz about tariffs to boost prices even for everyday necessities manufactured domestically. These should not be affected by import taxes. Others, such as Walmart, have exhibited more restraint.

General Motors has absorbed about $1.1 billion in increased costs through self-help measures, slimmer profits and only limited price increases. However, rearranging its supply chains will take years, and investors won’t tolerate hits to profits for very long.

Some businesses will mitigate higher costs by accelerating the buildout of AI, but that will destroy jobs.

In the months ahead, something has to give: Either inflation increases, unemployment rises or both.

The mix should determine the Fed’s next move.

As for Mr. Trump’s suggestion that Mr. Powell should lower interest rates to 1%? That’s a prescription for hyperinflation.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.