Federal Reserve Chair Jerome Powell said Wednesday that the era of super low interest rates that occurred between the 2008 financial crisis and the pandemic is likely over and that the neutral interest rate for hitting 2-percent annual inflation had probably risen.
Testifying before the House Financial Services Committee, Powell said that despite considerable progress on the fight against inflation, central bank interest rate policy was probably not going to return to the near-zero level that held between 2009 and 2017.
“We probably won’t go back to that era between the global financial crisis and the pandemic where rates were very, very low and inflation was very low — like extremely low,” he said. “I don’t think we’re going back to rates that are that low.”
Powell said that the baseline Fed interest rate necessary for achieving both low unemployment and price stability — the two parts of the central bank's "dual mandate" — has probably gone up in the wake of the pandemic inflation and subsequent price renormalization.
“We think that things like the neutral rate are driven by slow-moving forces, but ultimately you can see the effect. We have our policy rate over 5 percent now and it feels like policy is restrictive but not intensely restrictive. That suggests that the neutral rate of interest, at least as of now, will have risen somewhat, which means rates will get a little higher,” he told the committee.
Investors have been eagerly awaiting interest rate cuts by the Fed, which are seen by most market participants as having a stimulative effect on the economy, although there has been some recent speculation that higher rates may actually be boosting economic activity through interest income.
Recent upticks in unemployment as well as lower inflation readings in the personal consumption expenditures price index and consumer price index — two key gauges of inflation — suggest that the Fed may soon start cutting rates.
“The most recent monthly readings have shown modest further progress. Longer-term inflation expectations appear to remain well anchored,” Powell said, adding later in his testimony that rate cuts should come before inflation descends all the way to 2-percent due to the effects of price momentum.
Whether rate cuts come later this month or in September, or even later in the year, Powell’s Wednesday remarks about the longer-term neutral rate suggest that investors should not be expecting a reciprocal drop in rates to offset the rapid tightening cycle that took place starting in March 2022.
Fiscal conditions in the economy that may be behind some of the “slow-moving forces” responsible for the potential shift in the neutral rate are significantly different today than they were before the pandemic.
These include a ballooning in the national deficit, which reached a new plateau around 120 percent of gross domestic product, in the aftermath of the pandemic, as well as enormous private sector loans and tax credits that helped keep businesses afloat during the pandemic that are still being processed by the IRS.
