Federal Reserve should not lower interest rates

OPINION:

After cutting interest rates in September and October, the Federal Reserve should pause at its December meeting to best serve its mandate to accomplish price stability and maximize employment.

In the summer of 2023, the economy was at full employment but continued to grow robustly.

From September 2023 to December 2024, it added 174,000 jobs monthly, even though the Indigenous population growth and legal immigration could support about 90,000 additional workers a month. The balance of new employees was illegal immigrants.

With President Trump’s deportations and tightened legal pathways for immigration, attainable legal additions to the workforce have now fallen to about 55,000 a month.

Since May, job creation has been choppy, but it has averaged 44,000 jobs monthly through September.

Considering the mismatch between the skills of job seekers and the requirements of available positions, which is markedly exacerbated by artificial intelligence, that’s likely what the economy can accomplish.

Additional stimulus from lower interest rates would juice inflation much more than it would add more jobs.

Since March 2021, inflation has been well above the Fed’s 2% target.

In September, the consumer price index was up 3%, with Mr. Trump’s tariffs contributing perhaps 0.5%.

That’s not encouraging. We likely have seen only half the effects of those levies if the Supreme Court does not strike down most of them.

Inflation for services tends to run hotter than for goods. After subtracting energy-related items, services inflation was 3.5% in September. Those activities represent 61% of the CPI.

Goods, less the volatile food and energy commodities, are 19%.

In 2023 and 2024, core goods inflation was often negative and partially offset services inflation. Now those prices are rising by about 1.5% a year.

Economists, especially policymakers at the Fed, place a lot of stock in expectations about future inflation, and consumer expectations have hardened.

The Conference Board and University of Michigan surveys put those closer to 5% than 2%.

Even if exaggerated, that is a well-founded fear because, until at least recently, producers abroad and American businesses, such as automakers, have been absorbing many of the cost pressures from the Trump tariffs. That can’t hold forever.

Wrapping all that together, we can expect inflation to be close to 3% next year. Any shock could boost it further.

Oil is a good candidate.

It is trading near the bottom of its sustainable range, close to $60 a barrel.

Below that, some U.S. shale and Canadian production becomes unprofitable and could begin phasing down.

Russian, Iranian and Venezuelan oil are subject to U.S. sanctions, and Russian and Iranian oil to tightening EU sanctions. Together, those constitute more than 15% of the global supply and could be disrupted by military actions.

President Biden substantially depleted the Strategic Petroleum Reserve to bring down inflation as he prepared to run for reelection. Now that safety value is less available to Mr. Trump.

We have considerable data independently collected by the Federal Reserve, industry associations and commercial statistical services. Those indicate that the economy remains on a reasonably good footing for long-term growth, the immediate effects of the government shutdown notwithstanding.

Job creation has been slowed primarily by Mr. Trump’s deportations, his stricter stance on immigration overall, uncertainty about tariffs, and the downsizing instigated by AI.

In October, payroll processor ADP and Revelio Labs estimated that the private sector added 42,000 and 13,100 jobs, respectively. State and local hiring would add to that.

The government shutdown and the Trump administration’s reductions in force will subtract from those figures, but the government reopening makes those effects transitory.

In 2025, AI investments accounted for the lion’s share of growth in capital spending and added 1% to overall growth in gross domestic product.

In 2026, AI’s boost to aggregate demand and GDP will likely be 1.5%, and Mr. Trump’s tax cuts should add a comparable boost.

On the supply side, AI will likely boost productivity 0.8% to 1.5% a year on a scale similar to the transcontinental railroads, moving assembly line and interstate highway system.

Hence, we can accommodate a slower pace of hiring and still support GDP growth in the range of 2.5%, right on the trend set during the first Trump and Biden presidencies.

The economy should have no problem continuing to grow once the tariff situation stabilizes.

Should the Supreme Court strike down most of the Trump tariffs, the impact would be another large tax cut.

Mortgage and business borrowing interest rates tend to track the 10-year Treasury rate, which is currently about 4%.

Even if economic growth slows to about 2% and inflation is about 3%, the neutral rate, consistent with neither accelerating inflation nor excessive unemployment, should be 5% for 10-year Treasurys.

By that reckoning, monetary policy is too loose.

The Fed should stand pat for now and see what happens at the Supreme Court regarding Mr. Trump’s tariffs.

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