The Fed Just Made Us Even Dumber

The Fed cut rates by only 0.25%, which looks like a mistake. Here’s why:

1. This will make it even more difficult to hit the 2% inflation target.

2. Because the tightening was associated with a cut in the target interest rate, many pundits will wrongly conclude that policy eased. When this move does nothing to boost inflation, these same pundits will wrongly conclude that monetary policy is ineffective.

Why they think a policy that pushed up the dollar in forex markets is “expansionary” is beyond my comprehension, but that’s the world we live in. Thus monetary policy discourse is set to become even dumber. A fifty basis point cut would have made the discourse slightly less dumb. The general rule is that when the Fed moves rates in the same direction as the equilibrium rate, but more slowly, the discourse gets dumber.

3. Congress is currently running the most expansionary fiscal policy in history (given peace and prosperity), and this move will lead to calls for an even more expansionary fiscal policy. More fiscal stimulus will not help, rather it will be offset by monetary policy.

4. Long-term bond yields fell, but not because policy was easier than anticipated. Just the opposite. Yields fell because policy was more contractionary than expected. I.e., the income and Fisher effects are driving long-term yields lower.