A dumb lie about the economy, interest rates and the 2024 election

In case you haven't noticed, there is a US presidential election this year. Given the importance of the election, it is not surprising that many conspiracy theories have emerged. In almost all cases, I have no more insight into the election than any average American citizen, but given my role as a business economist, I feel the need to confront at least one conspiracy theory head-on: The Federal Reserve is trying to boost President Joe Biden's re-election chances.

After trying to tame inflation by raising interest rates for the past two years, the central bank is moving towards cutting rates soon. The policy shift has prompted claims that the central bank is „being political” because, in standard economic theory, lowering interest rates will stimulate the economy and make it easier for businesses to borrow, invest and hire. Rather than a dispassionate response to the shifting sands of the economy, the theory goes, the reason for the impending rate cuts is because the Fed and its chairman, Jerome Powell, hate former President Donald Trump and want to keep Biden in office. Better to lower rates to boost the economy, the thinking goes, improving voter perception of Biden heading into the 2024 elections.

Now, most of the commentary that says the Fed is trying to boost Biden comes from former Trump administration officials or others. Pro-Republican commentatorsBut that doesn't mean Democrats are immune to trying to politicize the Fed. Representative Ro Khanna, a Democrat, said the Fed should be cut Interest rates or Powell „may be the person most responsible for Trump's comeback.”

Regardless of which party troubles the central bank, it's important for Powell and other central bankers to stay aloof from politics. An apolitical independent central bank is a good thing for everyone because monetary policymaking free from political pressures can lead to a more stable economy. Setting interest rates should be about weighing costs and benefits for everyone, not engineering outcomes for a favored constituency. When people (usually the politically interested) try to accuse the central bank of bias, it erodes trust. Don't fall for these lies: The accusation that the Fed is trying to boost politics or Biden's re-election chances has some obvious problems.

Rate cuts, they make sense

The first part of the „Fed is trying to one-up Biden” conspiracy theory is the idea that the Fed suddenly reverses its inflation battle, like Powell flipping a coin once the election is in sight. There's an easy way to check this idea: Each quarter, the Fed releases its Summary of Economic Forecasts, which breaks down Fed governors' and board members' forecasts for gross domestic product, inflation, unemployment, and the appropriate federal funds rate. These forecasts are conditional and not a guarantee of what the central bank will do, but they provide a useful picture of the thinking of various members about economic conditions at the time.

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In its most recent briefing, published in December, the central bank signaled that it plans to cut rates from 5.5% to 4.5% by the end of 2024. This is a change from the previous forecast published in September, which put the 2024 year-end rate at 5%. This change was seen as a sign from the „fed politics” camp that Powell et al. laid the groundwork for more cuts, thereby boosting Biden's economy. In fact, December's 4.5% forecast was the same rate predicted in June's summary of economic projections – the September release was wrong. Rather than suddenly changing course, the summary shows that Fed members began projecting 2024 rate cuts in June 2022, about 1 ½ years in advance.

Second, there is nothing special about recent revisions to the central bank's interest-rate forecasts. Inflation is falling faster than expected and the US job market, while solid, has shown early signs of faltering, so it stands to reason that the Fed will act accordingly.

Rather than some political conspiracy, the rate cut forecast is just rules-based common sense.

Although the unemployment rate remains low, it has risen somewhat from its recent lows, and other labor market indicators such as hiring and exit rates have weakened in recent months. Based on the signs we've seen from the economy, the central bank's adjustment to its forecast is more consistent with what's known as the Taylor rule. The rule says that when forecasts for inflation fall, the central bank's forecast for its key interest rate should also fall. In its December summary of economic projections, the central bank revised its forecast for core personal consumption expenditure inflation in 2024 – the central bank's preferred measure of inflation – downward by a total of 0.7 points. According to the Taylor rule, the Fed should have also lowered its forecasts for federal funds interest rates — and it did. A rule of thumb is to cut interest rates in half for core personal consumption expenditures, so another 0.35 basis point from the federal funds rate, which it did exactly. Rather than some political conspiracy, the rate cut forecast is just rules-based common sense.

A third reason is that the politico-centrism idea makes no sense, and history suggests that Powell and other members work well within the paradigm. Our adjacent chart shows where unemployment and core inflation have been during the Fed's first interest rate cuts in the past. The unemployment rate, on average, was up 0.3 percentage points from its low, while core-per-capita-consumption-expenditure inflation was 2.5% at an annual rate in the three months before the first cut. Where are we now? The core unemployment rate stood at 3.7%, 0.3 points higher than its previous 12-month low, while core PCE inflation rose at an annual rate of 2.16% over the past three months. That means core inflation is actually running slightly below where it normally is when the central bank starts tapering. There is nothing unusual about these cuts.

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And, it's not like the Federal Reserve is acting alone. Several global central banks have already started cutting policy rates, and markets are indicating that investors are already expecting more rate cuts from G10 (the 10 countries representing the most traded currencies) central banks in the coming year. Are all these central banks bailing out politicians for re-election? These countries – Canada, the UK, Australia and Japan – do not hold national elections until 2025.

It should also be noted that many of those who accuse the central bank of politics have argued that monetary policy has „long and variable lags,” meaning that changes made in interest rates today will be felt in the economy 12 to 18 months later. If that's true, a political central bank should have already cut, guaranteeing that the fallout will grease the economy in time for this fall's elections.

Finally, for all the nonsense about „Biden appointees” or that this is a Fed controlled by Biden, the same Fed has shown itself to be apolitical. Some point the conspiracy theory to an article written by Bill Dudley in August 2019, shortly after he stepped down as chairman of the New York Fed. In it, Dudley wrote that if the Fed boosted the economy by cutting rates, the Fed would implicitly implement Trump's trade war — a move Dudley thought would be seriously misguided. It was a provocative piece by Dudley's own admission, but his former colleagues seemed to ignore it: the Fed cut rates twice. Trump-appointed Federal Reserve Governor Chris Waller to cut today and say he squeezed toothpaste out of a tube. He's the one who made the playbook public: they follow a rules-based framework where changes in the inflation rate are changes in their policy rate. It is also worth noting that the Fed is currently headed by Trump's nominee, Powell.

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The real reason for the allegations

The whole conspiracy theory about a political Fed is weak on its face and baseless on its merits. The Fed's rationale for rate cuts makes perfect economic sense: Inflation is falling faster than expected and there are enough signs of labor-market softening to start cutting the federal funds rate. (Of course, there are reasons to debate whether cuts come with risks — heating up the economy later, or if it makes sense to look at realized inflation rather than expected inflation — but that's not what this debate is about.)

Indeed, those who accuse the Fed of politicking are politicizing themselves. Opponents of the Fed are pessimistic about the economy and want the economy to remain weak, and this could help bolster their economic forecasts or boost their chances of employment in a Republican administration. And rapidly cooling inflation makes it harder to use higher prices as political maneuvering. Instead of accepting the economic reality as it is, they start from an end first and work backward.

Opponents of the Fed are pessimistic about the economy and want the economy to remain weak, and this could help bolster their economic forecasts or boost their chances of employment in a Republican administration.

However, all complaints about the Fed's actions won't have much impact on the outcome of the election: Conditions are grim until the 2022 midterm elections, and by most accounts, Republicans are unable to take advantage of the situation. What ensures that they will do well in 2024 with falling inflation, falling interest rates and rising stocks?

There are reasons to criticize the central bank. It may have been too relaxed during epidemics. They may have been too slow to normalize the policy. Those mistakes can at least be justified by faulty analysis – many people made the same mistake. However, accusing the central bank of politics is a different kind of criticism. In this case, it assumes the central bank has political will, which undermines confidence in the institution. If the central bank loses credibility, for whatever reason, it will be a serious problem for the US economy. Given that fact, it's important to reject baseless attacks on the Fed and acknowledge the impending rate cuts: an effort to maintain low unemployment and stable inflation.


Neil Dutta He is Head of Economics at Renaissance Macro Research.

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