Remember the Eighties?

Answer: My thoughts are that the “Fed,” or Federal Reserve Open Market Committee (FOMC), should have lowered interest rates some time ago, specifically during the first half of this year, for reasons we’ll review below. But first, to help understand the Fed’s role in economic activity, it’s worth remembering that interest rates are essentially the “cost” of money, whether for the cost of borrowing or the cost of lending. The “cost” of money has remained relatively high and is hampering economic growth.

When the economy is overheated, the Fed can step in and slow or temper growth by increasing the cost of money and raising interest rates. When the economy is slow, a reduction in interest rates typically increases activity by lowering the “cost” of funds. Delaying action at this time raises the risk of a recession as economic momentum slows.

The uncertainty caused by this administration’s tariff policies, joined with already high interest rates, influences housing markets, mortgage rates, and small business economic decision-making. The Fed could support these economic sectors by lowering rates. If lower rates did cause inflation, the Fed could easily adjust rates downward if necessary.

Remember the Eighties?

Speaking of inflation, do you remember the high inflation and low growth rate characteristics of stagflation we experienced several decades ago? This isn’t something we’re at risk of seeing in this environment. The term stagflation was coined back in the 1970s and 80s when both inflation and slow growth were problematic. As a teenager during those years, I remember the high gas prices resulting from the 1973 OPEC oil embargo and then the 1979 Iranian Revolution when oil shot up from $3/barrel in 1973 to $40 in 1980. This placed pressure on households and producers trying to keep up with higher gas prices at the pump and associated with the production and delivery of goods and services.

Inflation hit a high of 13.5% in 1980. At the same time, unemployment soared from 4.9% in 1973 to 10.8% in 1982. Higher prices caused reduced demand, which led to slowdowns in manufacturing and fewer jobs. It was a spiraling negative feedback loop that brought stagflation.

What’s different today is that we’re seeing increased productivity and efficiency. Much of this is due to artificial intelligence, which leads to lowered prices and increased demand: a positive feedback loop.

The Misery Index (the sum of inflation and unemployment) is a tool used to assess stagflation risk. This measure is at historically low levels, indicating that the United States is not currently at risk of stagflation. The biggest difference between now and the 70s-80s is that the Fed has tools and procedures it did not have access to back then. The Fed has an inflation target of 2.0% and will use monetary policy to achieve this target. The average rate of inflation during the last 60+ years has been 3.2% with the current inflation rate at 2.6%. Even if tariffs increase inflation by 1%, we’re a long way off from the inflation rates of my teenage years.

With subtle signs of economic weakness from job reports, including reductions in federal government payrolls, it may be time for the Fed to take notice and cut rates. Acting sooner than later to begin lowering interest rates, making monetary policy less restrictive could help sustain the current economic expansion.

The Fed meets again on September 17th for their next Federal Open Market Committee meeting. According to the “Fed Watch” tool, there is a 90% probability of a rate cut at this meeting. Weaker jobs data, along with manageable and steady inflation numbers indicate that we could likely see a one-quarter percentage point rate drop, with another ¼% point reduction later this year.

The Fed lowered rates by 1% in late 2024 and has kept the federal funds rate at 4.25% - 4.5% since December 2024. The perceived inflationary pressure of Trump’s proposed tariffs is cited as one reason the Fed has held off on lowering rates. Fed Chairman Powell himself has noted that businesses are absorbing tariff costs. These issues influence the upcoming decisions of the Fed as to whether or not, and when, they may lower interest rates. Stay focused and plan accordingly.