The Federal Reserve is officially worried.
It’s worried that manufacturing seems to be slowing down, that business investment doesn’t seem to be picking up, that inflation doesn’t seem to be, either, and that a potential trade war would only make all of this worse. Maybe most of all, though, the Fed is worried that this doesn’t seem to be happening here alone but all around the world, too.
That said, it is not so worried that it is ready to do anything about it yet. Sure, job growth has slowed down, and wage growth has, too, but they are both still growing. Not to mention that consumers, whose spending makes up about 70 percent of the economy, have remained resilient through all of the recovery’s recent bumps and bruises. Which is to say there’s been just enough good news that the Fed felt as though it could afford to leave interest rates where they are at 2.25 to 2.5 percent at the same time it signaled it was prepared to cut them if things don’t start looking better soon. Not that the Fed expects them to. Indeed, eight of the Fed’s 17 members think it will end up cutting rates at least one time before the end of the year, and seven of those anticipate that it will do so twice.
The Fed, in other words, is not quite ready to start cutting interest rates, but it is getting ready to do so.
This is significant even if interest rates do not change. It means the Fed is no longer focused on trying to get rates back up to what it considers a normal level but is, instead, primarily concerned with making sure the economy is growing at a normal pace. It is a shift that the Fed, for its part, thinks is going to last awhile. It is not just, as we mentioned before, that eight Fed officials believe interest rates will be lower at the end of 2019 than they are now. No, it is that nine Fed officials think that will also be the case at the end of 2020, and seven think it still will be at the end of 2021.
The question, then, is how trade tensions today could result in lower interest rates two and a half years from now. The answer is: They probably would not. What’s going on, then? Well, the simple story is the economy has a lot more problems than just President Trump’s Oprah Winfrey approach to tariffs. (You get a tariff! And you get a tariff! And you get a tariff!) Which, to be honest, should not be that much of a surprise. The Fed, after all, has been trying to tell us that for a long time now. It has to do with what’s known as the natural rate of interest, which is their Goldilocks level that neither speeds up nor slows down the economy. The reason we care about this is the higher it is, the faster it means the economy can grow. Which turns out to be particularly bad news right now, since the Fed has lowered its estimate of the natural rate from 4 or 5 percent before the financial crisis hit to, after another 0.3 percentage decline at its latest meeting, 2.5 percent today.
When the natural rate is this low, interest rates do not have to be that high to hurt the economy. That, in turn, means while it does not take much to justify cutting rates, it takes a lot for it to make sense to raise them again. Anything, then, that pushes rates down in the short term — like, say, the threat of a trade war — might be enough to keep them there in the long term. It is important to keep in mind, though, that this is not so much a story about how bad tariffs are but, rather, how weak economic growth is. That’s not just a U.S. story. The whole world is stuck in a low growth, low interest rate trap where their economies need stimulus more than ever, but it is harder than before to deliver that, because rates are already at or close to zero. Even Trump’s $1.5 trillion deficit-financed tax cut was not enough to change this for more than a year. Growth, both the Fed and markets are telling us, is quickly reverting to the slow and steady pace that prevailed before Trump’s act of corporate largesse.
That should make everyone worried.