[New York Diary] Fed's Big Rate Cut Rekindles Independence Debate

"The interest rate cut was necessary, but the 0.5 percentage point cut was a political act." (Former President Donald Trump)

The U.S. Federal Reserve (Fed) pulled the trigger on an interest rate cut on the 18th (local time), drawing criticism from the Republican Party that it was a political act. This rate cut comes 30 months after the Fed began raising rates in March 2022, declaring a 'war on inflation.' Coincidentally, it occurred less than 50 days before the November presidential election. Both the rate cut and the Republican backlash were expected. The market was already confident of a policy shift in September as inflation eased and employment cooled. Trump, the Republican presidential candidate, repeatedly pressured the Fed against a rate cut before the election, calling it "something that should not be done."

[Image source=Yonhap News]

As Trump suggested, the Fed's rate cut does appear to favor the ruling Democratic Party. Although inflation has dropped from a peak of 9.1% in 2022 to 2.5% in August, the inflation felt by Americans remains high. This explains the lukewarm assessment of Bidenomics despite the U.S. economic boom. In this context, the Fed's rate cut can signal to voters that the monetary authorities have won the war on inflation and can provide relief to households and businesses suffering from rising interest rates.

The controversy over the Fed's political independence is nothing new. The Fed has been thrust back into the political spotlight due to the historic inflation not seen in about 40 years, the cumulative effects of intense tightening over the past three and a half years, and the U.S. presidential election climate. Adding fuel to the fire, leading presidential candidate Trump has ignited the debate with his characteristic harsh rhetoric. President Joe Biden is no different. After the Fed's rate cut decision, he claimed, "Since becoming president, I have never had a conversation with the Fed chair," but this was quickly exposed as false. According to a fact check by the U.S. economic daily The Wall Street Journal (WSJ), Biden met with Powell at the White House in November 2021 and urged him to work on mitigating the risks that climate change poses to the financial system and economy. The president, who has the power to appoint the head of the monetary authority responsible for price stability and full employment, unexpectedly pressured the Fed to adopt climate policies. Powell responded two years later in 2023, stating, "We are not climate policymakers, nor will we become them."

Whether the Fed's big cut (0.5 percentage point rate cut) was an independent decision or politically motivated is open to interpretation. What matters is that the basis for Fed policy decisions should be the impact on the U.S. economy and, consequently, the global economy?not the effect on the U.S. presidential election. The U.S. unemployment rate jumped from the 3% range in the first half of the year to the 4% range in the second half. The urgent situation now is to prevent a recession rather than stabilize prices. There was little room for political considerations to intervene. Wall Street consensus is that the Fed should have cut rates earlier in July.

Powell misjudged inflation as "transitory" in 2021, contributing to the era of decades-high inflation and painful tightening. The only way to make up for that mistake three years ago is to achieve a soft landing without a recession. Powell himself is the person who understands this best. Fortunately, Powell and other Fed officials seem to be focusing on their core role as technocrats rather than political considerations. Christopher Waller, a Fed governor mentioned as a candidate for the next Fed chair, said at an event earlier this month, "If the president wants to complain about monetary policy, he has the freedom and right to say all the damn opinions he wants." The true sentiment of Fed officials seems to be captured in Waller's next statement: "That doesn't mean I will listen to him or adjust policy."