A recent article in The Economist discussed what they believe to be the president-elect’s views on interest rates:
A more aggressive Fed could in turn draw the wrath of Trump, who has insisted that as president he should have a say over interest rates. He will certainly want to see sharper rate cuts now that he is in charge.
This reminds me of a story titled The monkey’s pawin which the main character is given three wishes, which do not turn out as well as intended. Let’s look at some possible outcomes, and then evaluate the kind of interest rate path Donald Trump has been on should prefer.
1. In most cases, steep interest rate cuts are associated with recessions. Recent examples occurred in 2020, 2008 and 2001. Recessions are not popular.
2. You could argue that The Economist meant that Trump prefers a sharp drop in interest rates in combination with a strong economy. And the economy seems pretty strong right now, with the Atlanta Fed predicting 3.3% growth in the fourth quarter. But there is a significant risk that a sharp cut in that scenario could lead to high inflation. At the moment the futures market for fed funds predicts some rate cuts over the next few months, but at a slower pace of decline than we have seen in recent months. At the same time, market inflation expectations are slightly above target. If, despite robust NGDP growth, the Fed were to implement even “steeper rate cuts” than has occurred in the recent past, there would be a very real risk that inflation will accelerate again. Inflation is not popular.
3. Perhaps the Fed’s interest rate target is still well above equilibrium. (But why is growth so strong?) Perhaps it will be possible to lower rates and keep the expansion going, as we saw in 2019 and 1998. But we have already seen a 75 basis point reduction. It would be virtually unprecedented to see an even sharper cut from now on, without reigniting inflation or being a reaction to the recession.
To be clear, I’m not saying we’re likely to have a recession or high inflation. But that’s because I don’t expect even sharper interest rate cuts. I expect the pace of interest rate cuts to even slow in 2025. And I believe this would be the best possible outcome. I will indeed go further. If these three scenarios were fully explained to Trump, I doubt he would be in favor of “steeper rate cuts,” especially if he had recently read The Monkey’s Paw.
Or Goldilocks and the three bears.
This is an illustration from The Monkey’s Paw: