Economists note that on average, it takes more than three years for tight monetary policy to eliminate inflation, but the Fed exited the policy after just 30 months of tightening rates.
Peter Morici, an economist and emeritus business professor at the University of Maryland, recently wrote that premature rate cuts usually lead to a rebound in inflation, but in the short term, if the United States can avoid a recession, rate cuts should boost stock prices. Here are his views.
Stock market investors should cheer that Federal Reserve Chairman Jerome Powell believes inflation is all but gone.
The Fed recently cut its federal funds rate by 50 basis points, a move typically taken in response to economic crises, such as the global financial crisis.
For now, such a disaster does not appear imminent. The U.S. unemployment rate of 4.1% is low by historical standards; the ratio of job openings to unemployed people has normalized, and Powell expects U.S. GDP to continue to grow at an annual rate of 2.2%.
Powell said that "inflation is continuing to move toward 2%" and that inflation expectations are currently "well contained." But the average results of surveys from the University of Michigan, the New York Fed and the Conference Board show that consumers expect prices to rise by 3% or more next year.
That's not surprising. Rising prices for rent, homes, auto insurance and other services have pushed up the cost of living for Americans. Vice President Harris, a Democratic presidential candidate, has pledged federal action to correct grocery store price gouging and a severe housing shortage.
The progress on inflation was mainly reflected in commodity prices.
In August, the consumer price index (CPI) rose 2.5% year-on-year, but core inflation, excluding energy and food prices, was 3.2%. Meanwhile, rents rose 5% year-on-year and overall housing costs rose 5.2% year-on-year as builders faced land and labor shortages and rising regulatory costs. Most troubling, service prices excluding housing and energy rose 4.5% year-on-year.
The economy has added an average of 203,000 jobs a month over the past year, far outstripping the 80,000 new jobs that would have been created by population growth and legal immigration. Newcomers who have been granted temporary asylum or otherwise admitted to the country are also working.
Despite President Joe Biden’s tightening of border controls, the number of migrants remains well above pre-pandemic levels. The surge in immigration is likely responsible for much of last year’s 3.4% unemployment rate, calling into question warnings of a recession premised on joblessness.
Job demands are changing. For example, tech giants like Microsoft, Alphabet, Apple, and Meta Platforms are cutting jobs but investing more in developing AI products.
Layoffs have not yet escalated to the point where they would lead to a vicious cycle of layoffs-unpaid furloughs-decline in consumer spending.
Powell said in 2021 that the inflation surge would be temporary, but he was wrong. Powell blamed the collapse on the coronavirus pandemic and supply chain disruptions, but the Fed has provided trillions of dollars in federal spending during the pandemic by printing $4.8 trillion and buying U.S. Treasury bonds.
Now, Powell's bold rate cut has broad support. The big rate cut will stimulate financial liquidity by allowing banks to borrow and finance more cheaply and reduce fees on credit card balances, auto loans, home equity loans and mortgages. Small businesses that rely on revolving lines of credit should also receive lower rates.
Don’t be surprised if inflation rises next year — as it did when former Fed Chairman Arthur Burns abandoned monetary discipline to boost the economy during the Nixon administration.
More than 100 inflation experiences in 56 countries since the 1970s have shown that premature interest rate cuts usually lead to a rebound in inflation, more unemployment and greater macroeconomic instability.
On average, it takes more than three years for tight monetary policy to eliminate inflation, but the Fed exited this policy after only 30 months of tightening rates.
Yet even if inflation picks up again, stock market investors should benefit. In the 40 years before the 2008 global financial crisis, U.S. inflation averaged 4.0%, 10-year Treasury yields were 7.4%, existing home yields were 5.6%, and the S&P 500 averaged an annual return of 10.5%. In the short term, if the U.S. can avoid a recession, low interest rates should boost stock prices.
