The Long Game: Why the Fed Must Resist Calls for Premature Rate Cuts
Insights From the Publisher: By keeping rates relatively higher longer, the Fed has the opportunity to avoid the missteps of the 1970s.
By Damon Elder, publisher and editor-in-chief, The DI Wire
As inflation rates continue to ease from the highs seen in recent years, pressure is mounting on the Federal Reserve to relax its monetary policy. History, however, shows us that quick fixes often lead to bigger problems down the road. The Fed must ignore the calls for rate cuts. Instead, it must stay focused on the long game and keep inflation under control, even if it means some short-term pain.
A chorus of voices is urging the Fed to lower interest rates. Mark Zandi, chief economist at Moody’s Analytics, recently expressed concern, stating that “something could break” if the Fed does not reduce rates. “If I were king for the day, I would really be cutting rates at this point,” he said in a recent interview with Yahoo Finance. Jeremy Siegel, professor emeritus of finance at the Wharton School of Business, stated in his recent weekly commentary that he would “like to see the Federal Reserve cutting rates as soon as July.” President Biden said that he expects a rate cut before the year is out. And for what it’s worth, Elon Musk, chief executive officer of Tesla and SpaceX, dedicated many of his tweets over the past year or more to criticizing the Fed for raising rates.
These concerns are understandable, as higher interest rates can undoubtedly dampen economic activity. We must not forget the lessons of the 1970s and early 1980s, however, a time marred by runaway inflation that exceeded a staggering 14% in 1980. This period of economic turmoil, aptly dubbed the “Great Inflation,” was fueled by a series of policy missteps, including a focus on nonmonetary factors such as oil price shocks and government budget deficits, along with premature easing of monetary policy during an election year. Only when Chairman Paul Volcker painfully raised rates to 20% did inflation start to return to normal. By 1983, inflation was just over 3%.
The consequences of the Great Inflation were severe, with soaring prices eroding savings, disrupting financial markets, and ultimately leading to a prolonged period of economic stagnation. Arthur Burns, the Fed chairman during much of the 1970s, would go on to admit in his 1979 writing, “The Anguish of Central Banking,” that under his leadership, a “restrictive stance had not been maintained long enough to end inflation.”
The 1970s also taught us that the costs of inflation extend far beyond economic metrics. The Great Inflation was a cause of much instability for many Americans as they found it difficult to plan their purchasing from week to week, and unpleasant choices and sacrifices had to be made. The social and psychological toll of constantly rising prices can be immense, leading to widespread uncertainty, anxiety, and overall loss of confidence in leadership. According to a Gallup poll, only 12% of Americans were satisfied with the way things were going in July 1979. Moreover, the erosion of purchasing power often disproportionately affects the most vulnerable segments of society, exacerbating inequality, inequity, and social tensions.
Jerome Powell, current Fed chairman, seems acutely aware of the risks associated with premature easing. In a speech last year, he emphasized the importance of “keeping at it until the job is done,” referring to the Fed’s commitment to restoring price stability. More recently at a meeting of the Foreign Bankers’ Association, Powell restated his view that we “need to be patient and let restrictive policy do its work.” This resolve is crucial, as history shows that once inflation becomes entrenched, it becomes exponentially harder to control.
Taming inflation is a marathon, not a sprint. While the temptation to appease short-term concerns is strong, the lessons of the past are clear: short-term pain is preferable to long-term economic instability. The Fed must stay the course and remain focused on its long-term mandate of maintaining price stability. This means keeping interest rates higher for as long as necessary to ensure that inflation is truly under control. The path may be bumpy, but the alternative, a return to the inflationary spiral of the 1970s, is far worse.
Damon Elder is the publisher and editor-in-chief of The DI Wire. He has worked in the alternative investments industry for nearly 20 years. He was previously a congressional aide and political consultant before finding honest work in the private sector. Agree or disagree? Share your views with him at damon@thediwire.com. Thoughtful replies may be published in The DI Wire.
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