Experts explain Federal Reserve Board Meeting, potential interest rate cuts
The Federal Reserve is meeting at the end of July, under the watchful and expectant eye of the entire financial world. While many were expecting more aggressive interest rate cuts throughout 2024, the Fed has taken a more cautious approach, with inflation slowly falling and unemployment rates remaining steadily low. What should we expect for the rest of the year, and how will it impact both the economy and, potentially, the 2024 election?
Virginia Tech economist David Bieri and finance expert Andrew MacKinlay offer perspective on how we arrived where we are and what is to come.
What role does the Federal Reserve have in controlling inflation?
“There is a presumption that the Federal Reserve can control inflation by interest rates,” says Bieri, who analogizes interest rate cuts like a delayed brake pedal for inflation. “The Fed doesn’t really know until much later what’s worked.”
But market movement is at least as much about what happens relative to expectations as it is the actual movement of economic conditions. “We make predictions about the future, and then when these predictions are off, we change our behavior,” says Bieri. “The weather never retaliates when we get it wrong. But when policymakers get their predictions about the future wrong, agents adjust their expectations, and so the future will turn out different.”
What has worked so far, and what hasn’t?
“The target figure that everybody looked at — inflation rates — are coming down,” says Bieri. “Whatever they have done, they have done well. It was aggressive. It hurt. But it seems to be working.”
We won’t know until later on whether the drop in inflation was causational or correlational to interest rate cuts. But there have been other, negative impacts.
“Where it didn’t work is in terms of all these displacements,” says Bieri. “We will also see how much the policy discourse has suffered, because we simply thought that this was something the Fed could solve.”
What are the economic indicators that would likely precipitate a rate cut?
“Right now, the Fed is most focused on the inflation measures (PCE, Core PCE) and whether they continue to move down towards 2%, which is what they target,” says MacKinlay. “The most recent inflation reports have been improving although they are still above 2%.”
What is the likelihood of a cut happening, and how big of one should we expect?
Both Bieri and MacKinlay expect some sort of movement downward on interest rates, though exactly when and how much is the billion-dollar question.
“The accelerant is still in the economy,” says Bieri. “We still have sufficient demand, consumer spending has gone down a little bit, the economy is not as leveraged as it was before the great financial crisis, the banking sector is not as unstable as it was last year.”
On July 11 the Bureau of Labor Statistics released the June Consumer Price Index, and the reduction in inflation was a little better than expected. As a result, “It seems likely that a rate cut will occur unless other inflation data doesn't show the same positive trend,” says MacKinlay.
“What I can say with more certainty is that the Fed will cut the interest rate in 0.25% increments unless something big changes, like a large drop in economic activity. The Fed does keep stressing that any future rate cuts are data dependent, so if inflation stops improving they may only cut rates once or not at all.”
How will any of this impact the election, if at all?
“The textbook would predict to us that a rate cut would help the incumbent,” says Bieri, though any actual impacts would take months to actually filter into the economy in a tangible way. “What the Democrats need is the soft landing — no housing market meltdown, no regional banking meltdown, commercial real estate stable.”
What else should we keep an eye on?
“While hard to forecast, it is possible that there is some major economic shock—some new geopolitical event, another banking or financial crisis, or a sudden economic downturn—that would precipitate more aggressive interest rate changes and other monetary policy support,” says MacKinlay. “This would be very challenging as it would force the Fed to drop rates while inflation is still higher than they want.”
About Bieri
David Bieri is an associate professor in the School of Public and International Affairs and an associate professor of economics. He also holds an appointment in the Global Forum on Urban and Regional Resilience. His teaching interests are at the intersection of public finance, monetary theory and history of economic thought. He has held various senior positions at the Bank for International Settlements in Basel, Switzerland. Prior to his work in central banking, he worked as in investment banking in London and Zurich. View Bieri’s full bio.
About MacKinlay
Andrew MacKinlay is an assistant professor in the Department of Finance, Insurance, and Business Law in the Pamplin College of Business. His research focuses on corporate capital structure decisions and the effects of financial intermediation on corporate activity. He is the recipient of the Marshall Blume Prize in Financial Research awarded by awarded by the Jacobs Levy Equity Management Center for Quantitative Financial Research at the Wharton School, the Financial Research Association’s Michael J. Barclay Award, and the Douglas D. Evanoff Best Paper Award at the Chicago Financial Institutions Conference. View MacKinlay’s full bio.
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