Wednesday was Day 2 of Federal Reserve Chair Jay Powell’s testimony on Capitol Hill, and it sounded a lot like Day 1: We’re making progress on inflation, but not hanging a “mission accomplished” banner just yet.
For the better part of two years, as the Fed raised and kept rates high, the “long and variable lag” has been key to understanding how long it would take those rate hikes to slow things down.
Well, now that inflation is subsiding and the economy does show signs of slowing, Wall Street expects the Fed to start cutting rates sooner than later. But does the “long and variable lag” for rate hikes apply to rate cuts too?
Part of the Fed’s job is to take away the proverbial punch bowl before the economy gets too crazy and starts doing keg stands on the front lawn.
Fed Chair Jay Powell took away the punch bowl a while back with those rate hikes, and now, that party finally seems to be dying down.
“He’s got his hands on the punch bowl, he’s walking around the room with it, and he’s not sure whether to put it down on the table yet,” said Ann Owen, an economist at Hamilton College.
She said even when the Fed does decide to cut rates, the economy doesn’t immediately roar back to life. That’s partly because when would-be borrowers see one interest rate cut, they wait for more.
“If you are a person who’s thinking, ‘I want to buy a new car, but rates are just a little bit high.’ Well, when the Fed cuts rates eventually, they’re not going to do it just once. You should wait a little bit if you can, because they’re going to go down even more,” Owen said.
While economists agree rate cuts won’t instantly juice an economy, there’s really no consensus on just how long that lag is.
“It’s hard to say, because a lot of times when the Fed is cutting rates, it’s because the economy is already in a downturn,” said Wells Fargo economist Sarah House. “And so in some ways, it’s hard to really separate how much the rate cuts are doing when you already have a lot of other negative forces.”
So while history isn’t much of a guide, some research indicates that rate cuts don’t help the job market as much as rate hikes hurt it.
Michael Gapen, managing director and head of U.S. economics at Bank of America Global Research, said it’s easier to pull back economic activity than it is to generate it.
“Meaning you could cut interest rates all you wanted, but you can’t force a firm to hire, you can’t force a household to spend,” he said.
You know the old expression: You can lead an economy to a punch bowl, but you can’t make it drink.
