Dear Readers, On Wednesday (September 17), the Federal Reserve, the central bank for the United States, announced its latest monetary policy review. Monetary policy essentially refers to the supply of money and the cost of credit (read interest rate) in an economy. When a central bank of an economy wants to boost economic activity, it makes it cheaper for people to borrow money by reducing interest rates. Alternatively, when a central bank wants to rein in inflation — which is the rate at which prices increase from one year to another — it makes it costly to borrow money by increasing the interest rate. The interest rates also determine what happens to stock markets around the world: lower rates imply more money flowing to stock markets (read stock indices going up). When it comes to the US Fed, policy changes have wide ramifications not just for the US economy (which by itself is around 25% of the global economy) but also for the rest of the world. That’s because the interest rates set by the US Fed affect the rate at which anyone in the world can lend to the US government. Lending to the US government is considered to be the least risky loan, and the second safest bet to buying gold. Changes in monetary policy are often a snooze fest because tweaks in interest rates are generally small and rather infrequent, while most of the commentary around each policy review is pretty similar to past ones. Expected outcome hides several complexities And at one level, the latest policy review was no different. The US Fed announced that it will work towards bringing down interest rates by 25 basis points — that’s one-fourth of a full percentage point. This is exactly what was expected from the policy review; what is often referred to as “being priced in by the markets”. So, on the surface, nothing much changed. However, there are many complexities that this expected outcome hides. First, this review comes at a time when the US Fed (which manages the country’s monetary policy) and the US President (who manages the fiscal policy, which refers to government spending and taxation) are on a collision course. Since his election in November last year, US President Donald Trump has been progressively and openly berating the head of the Federal Reserve’s Board of Governors, Jerome ‘Jay’ Powell, for being “too late” in cutting the interest rates in the economy. Trump and his closest economic advisors have been levelling a variety of criticisms at Powell and the Fed, ranging from the Fed having a political bias against the Trump administration to the Fed becoming all too powerful in determining the economic destiny of Americans to the Fed becoming inefficient. Last month, Trump fired Lisa Cook, one of the governors in the Fed’s Board of Governors via a post on social media. The courts quickly ruled against it and allowed Cook to participate in the latest policy review even though the broader case against her carries on. On Monday, the Senate confirmed the appointment of Stephen Miran, a close Trump ally, to the Board of Governors. Miran, the man said to be responsible for Trump’s tariff policies, remains chair of White House Council of Economic Advisers, and has taken an unpaid leave of absence after his appointment. This, critics say, is unprecedented in the history of the US Fed and has serious implications for the central bank’s independence. Second, the US economy is going through a phase which would challenge the US Fed regardless of who is heading it. That’s because the US Fed has a dual mandate: achieving maximum employment and stable prices for the benefit of the American people. Typically, at any point in time, only one of these goals is a matter of concern for the Fed. That’s because high inflation happens when growth is surging and lots of new jobs are getting created. On occasions when growth is faltering and unemployment is rising, inflation is also quite low. But since the start of the year, growth has been faltering, unemployment has been rising even as inflation is starting to trend up (See charts). This means whatever the Fed does to boost growth — say cut interest rates — can fuel inflation. Alternatively, if it raises interest rates or keeps them at high levels to contain inflation, economic growth will get choked and employment will suffer. Many questions abound Thanks to the complexities, despite the rate cut, there are many questions that linger. Why cut interest rates when unemployment is still near historic lows? Why cut interest rates when inflation is still a concern? Would a 25 basis point cut solve the unemployment problem? What would such a cut do to inflation? Moreover, if the labour market is getting weak, why didn’t the Fed cut rates earlier in the year when Trump was demanding them? The list is quite long. Here are six quotes from the Fed Chair Jay Powell that bring out these conundrums and explain where things stand. 1. “A Curious Balance” On the face of it, the rate cut has happened because the Fed is concerned about unemployment trending up but the fact is that, at 4.3%, it is still low enough to not trigger a rate cut. Then why did the Fed cut rates? Powell says the US is in a “low firing, low hiring” phase. That is, few people are being fired from jobs but fewer still are being recruited. And his worry is that this situation can very quickly worsen substantially if firings increase. “Overall, while the labour market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising. And if those risks materialise, they can do so quickly in the form of sharply higher layoffs and rising unemployment,” said Powell during the Jackson Hole symposium on August 22. 2. “We were right to wait” The question then is: Why did the Fed wait this long? Speaking to reporters on Wednesday, Powell said: “I think we were right to wait to see how tariffs and inflation and the labor market evolved. I think we are now reacting to the much lower level of job creation and other evidence of softening in the labor market and that warrants a change in policy.” It is noteworthy that just on September 5 the Bureau of Labor Statistics has revised down the level of non-farm payrolls between April 2024 and March 2025 by over 900,000 — that is a revision that halved the original estimate. 3. “It is a risk management cut” The question still remains: What about inflation? It continues to inch up since April when it was trending down before it. Wouldn’t an interest rate cut risk spiking inflation? Powell said that people should see this rate cut as a “risk management cut” because if you look at the Summary of Economic Projections or SEP (a document the Fed produces) the projection for growth for this year (2025) and the next year actually ticked up just a little bit and inflation and unemployment (forecasts) did not really move. In other words, the Fed is trying to balance both the goals in a manner that neither becomes an overwhelming problem. 4. “A highly unusual situation” So what lies ahead? Would the Fed cut more in the remaining two meetings of the year in October and December? Would it continue to cut in 2026? Typically the aforementioned SEP provides some clues. The SEP is essentially an accumulation of individual projections by 19 decision makers of the Fed (including Powell). The SEP shows that 10 of the 19 decision makers believe the Fed would have to cut interest rates two more times in 2025 while the remaining 9 are of the view that no more cuts are required. Powell explained such a wide variation in views as follows: “It is quite an unusual situation. We have a situation where we have a two-sided risk and that means there is no risk-free path. And that’s quite a difficult situation for policymakers.” In other words, no matter what the Fed does or doesn’t do, the situation is such that there are risks either way. 5. “I see it as a court case” In any economy, governments are the biggest borrowers. And like any borrower, they want lower interest rates. A mark of faltering economy is that the fiscal policymakers (government) intervenes in the functioning of the monetary policymakers (the central bank). With Trump openly asking for a rate cut and berating the Fed chair, the fear the world over is that the US will lose the key attribute that makes it the most trusted financial system in the world: The Independence of the Fed. The rate cut is just part of the story. Without that independence, the whole edifice can crumble because it is the faith, across the world, that the Fed is free to conduct monetary policy without political intervention that is the main reason why everyone trusts using the US dollar. Does the Fed see the case against Lisa Cook, one of the governors on the Fed’s board, as an attack on Fed’s independence? Powell said that the Fed only takes decisions based on data without any regard to any party or political interests. He steered clear of the issue by stating: “ I see it as a court case. And that it would be inappropriate for me to comment on it” 6. “Windshield, not the rear view mirror” The sharp downward revisions in BLS data on employment over the past few months have raised many questions on the quality of data being used for policy analysis. Politicians like Trump and many of his economic advisors have said that the Fed would have cut rates sooner if they did not depend solely on poor quality data. In the press conference, a reporter from Fox News (which aligns closely with President Trump’s views on most issues) asked Powell if he would have cut rates sooner had he known that the employment situation was worse than what it actually was believed to be a few months ago. “We have to live life looking through the windshield rather than the rear view mirror,” said Powell. Upshot It is said that no man can serve two masters. At present the Fed finds itself in a similar predicament: It cannot do justice to its dual mandate thanks to both inflation and unemployment worsening at the same time. A large part of this problem is an artificial one: Trump’s tariffs and immigration policies have raised prices on the one hand and curtailed labor supply on the other. There is little that the US Fed could do about either. In the months ahead, the US Fed may undergo substantive changes, with calls for an independent inquiry into its functioning, even as the US goes for mid-term polls in 2026 Cutting interest rates may be a quick way to boost growth in the run up to the elections in 2026 but doing so will likely come at the cost of an all too familiar problem — high inflation — for the American public. How do you rate Powell as the Fed's chair? What strikes you more: *That the US Fed under Powell performed a miracle of sorts by ensuring that the US stay out of any prolonged recession in spite of shocks like the Covid pandemic and the Russia-Ukraine war or *The fact that the Fed under Powell has not been able to once meet the target of 2% inflation and even now projects that it would take another 2 years to get there. Share your views and queries at udit.misra@expressindia.com Take care, Udit
