Federal Reserve may cut rates soon, but its efforts may have less oomph due to changes in the U.S. economy
By Justin Lahart
Unnerved by mounting risks to the U.S. economy, the Federal Reserve is considering lowering interest rates. Rate cuts might not provide the economy with as much oomph as in the past, though.
Fed policy makers are holding a two-day meeting Tuesday and Wednesday and, while they probably won’t cut rates just yet, they are likely to signal a move could come as early as their July meeting.
Even with trade tensions and a shaky global environment darkening the U.S. outlook, the risk of a recession still seems low. But with its target range on overnight rates set at just 2.25% to 2.5%, the Fed doesn’t have a lot of dry powder. That makes it wary of waiting too long to support the economy lest conditions deteriorate, warranting deeper rate cuts than it is able to manage.
The economic response to a cut could be muted, though. Not only are there longstanding shifts in the makeup of the economy that over the past several decades seem to have diminished the power of rate moves, but the scars left by the housing bust and financial crisis may have made consumers in particular less responsive to rate cuts.
The slog out of the last recession was long and hard, but it was just the most disappointing in what has been a series of slow recoveries. The Fed cut rates deeply through both the 1990-91 and 2001 downturns. In both cases, the economy grew more slowly coming out of those recessions than it had before the 1990s.
Fed Chairman Jerome Powell speaks during a conference at the Federal Reserve Bank of Chicago on June 4. Photo: Scott Olson/Getty Images
A big reason is that the role of some of the most interest-rate sensitive industries in the labor force—the ones that hire like crazy in response to low rates—has been greatly diminished, argue economists at the Federal Reserve Bank of Kansas City. In 1980, construction and manufacturing accounted for about 25% of total U.S. employment. By the time the 1990-91 recession began, that had fallen to 21%, slipping to 18% before the 2001 recession and 15% ahead of the last recession. Now it is at 13%.
Another important difference between this last expansion and previous ones is that housing, after falling by so much in the downturn, had such a modest comeback. Home sales remain below their late 1990s levels, when the U.S. population was lower, and housing’s direct share of gross domestic product is now at levels which in other periods would have been associated with recession. The share of Americans who own the home they live in also has fallen.
Although lower rates might stimulate home sales a bit, a variety of forces are weighing on housing, including out-of-reach prices. This matters because housing is one of the ways that rate cuts have traditionally boosted the economy. Lower mortgage costs prompt people to buy not just a house but many other things—furniture and appliances—that go with it.
Mortgage refinancing—another avenue for lower rates to make their way into consumer spending—also might be lacking. Many homeowners already refinanced during the years coming out of the recession, locking in ultralow rates.
Then, there is the increased caution Americans seem to be taking with their finances since the financial crisis, leaving the saving rate substantially higher than before the recession. Even a decade later, memories of the severity of the downturn may still be too fresh for people to respond exuberantly to lower rates.
It could take more than just rate cuts to get the economy really going again.
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