What to know about the Fed’s interest rate cuts

On Sept. 18, the Federal Reserve announced a 50-basis point (bps) interest-rate cut, marking the first cut in four years and likely the last major policy action before the presidential election on Nov. 5. Financial experts and everyday citizens eagerly anticipated this pivotal decision, which seemed to serve as a proxy signal for the state of inflation, a pressing issue for many voters.

To understand the implications of the Fed’s recent actions ahead of the election, Penn Today spoke with Peter Conti-Brown, an associate professor of financial regulation at the Wharton School who specializes in central banking and the history and policies of the Federal Reserve System.

The ‘soft landing,’ a 50-bp cut, and an election

Conti-Brown says predicting how the Fed’s decision might influence market volatility is challenging, but he believes the Fed has engineered a soft landing, primarily meaning the avoidance of a recession, with a potential side effect of reduced volatility. This is indeed the Fed’s hope, as it values stability above all else.

“The Fed has almost never succeeded at a soft landing; 1994 is an exception,” he says. “If the Fed succeeds here, and it looks increasingly likely that it will, this will be a historic achievement.”

By cutting rates by 50 bps, Conti-Brown says, the Fed has signaled a desire to implement a significant correction, followed by smaller adjustments moving forward. “A 25-bp cut would have meant a steadier path of rate normalization,” he says. “We will wait and see if this plan bears fruit.”

The Fed has a mandate of promoting maximum employment and stable prices. The 50-bp cut, Conti-Brown says, is the first major signal that the Fed is now prioritizing recession risk over inflation risk.

Regarding the influence of Fed decisions on elections, Conti-Brown points out that both Richard Nixon in 1960 and George H.W. Bush in 1992 partly blamed the Fed for their electoral defeats.

“Because many elections in the U.S. are so closely contested, with margins of victory sometimes only tens of thousands of votes in specific swing states, it’s fair to say that an adverse macroeconomic outcome engineered by the Fed can be a decisive factor,” he says.

2 is the magic number

The Fed’s 2% inflation target appears within reach, but many consumers continue to feel the strain of elevated prices. To that end, the Fed has focused on “disinflation,” not “deflation,” according to Conti-Brown.

“This is a key distinction because consumers want ‘deflation’ in the grocery store but not in their debts or incomes,” he says. “Disinflation is the path the Fed has pursued, which means the rate of price growth has slowed to 2%, but prices are still increasing and will not return to their levels in 2021. But the Fed is correct here. Deflation is another word for depression, the causes of which are incredibly damaging to nearly every aspect of society and economy.”

Impact on other central banks

“Central banks coordinate intellectually but not in policy,” Conti-Brown says. “This means that the Fed—as a leader among central banks, given the international status of the dollar—will be taken seriously but won’t dictate policies.”

He adds that central banks have been opting in some cases to keep rates steady or to cut marginally. Other central banks still face inflation and deal with an interest rate environment that has little in common with the U.S.