LOWER INTEREST RATES ARE THE RIGHT POLICY FOR THE WRONG REASONS / PROJECT SYNDICATE

Lower Interest Rates Are the Right Policy for the Wrong Reasons

There is strong evidence to support the case for interest-rate cuts in the United States, given the disproportionate impact of higher rates on the most vulnerable. Yet with Donald Trump loudly demanding that the US Federal Reserve lower borrowing costs, the situation has become more complicated than it needed to be.

Mark Blyth, Nicolò Fraccaroli

PROVIDENCE – As its September meeting approaches, the US Federal Reserve is once again coming under political pressure to lower rates. 

President Donald Trump has been calling for such a move for months – sometimes demanding cuts as large as three percentage points – and openly attacking Fed Chair Jerome Powell and individual Fed board members.

Trump’s main motive in pushing for lower rates is to reduce government borrowing costs, which have spiked because of near-term inflation fears and longer-term worries about the sustainability of US debt. 

But while US inflation has fallen markedly from its 2022 peak of over 9% to 2.9% today, it seems to be trending higher again, and that complicates the case for rate cuts.

Specifically, economists worry that rate cuts could reignite inflation, especially now that tariffs are applying upward pressure on import prices. 

Although the pass-through from tariffs to inflation has been weak so far, the latest data suggest that higher prices may finally be materializing. 

Under these circumstances, lowering rates when markets expect higher inflation could do the opposite of what Trump wants: rather than falling, the government’s borrowing costs would balloon further.

But notwithstanding that risk, cutting rates now is not a terrible idea. 

The reason has nothing to do with what Trump claims, and everything to do with the historical evidence and the imperative to maintain some degree of equity.

When it comes to controlling inflation, there is less evidence for the efficacy of rate hikes than many assume. 

While the recent decline in inflation was widely attributed to the Fed’s monetary tightening, it does not line up with what one would expect from the broader history of monetary-policy changes. 

Moreover, while it’s commonplace to argue that higher rates will curtail inflation, it is just as common to insist that monetary policy works with “long and variable lags,” which suggests that the interest-rate lever is not as tightly coupled to the inflation rate as we would like to believe.

In fact, recent research shows that the causal link between rate hikes and lower inflation is weaker and more delayed than is often assumed. 

The authors analyzed around 150,000 estimates of the effect of monetary policy (from more than 400 studies) and found that, following a 100-basis-point rate hike, prices are unlikely to fall by more than 0.15% after four years.

Now, recall that the Fed raised rates by more than 500 basis points between 2022 and 2023, yet inflation dropped from over 9% to about 3% – 600 basis points in barely two years. 

Unless rate hikes suddenly acquired a miraculous degree of efficacy, much of that decline must be due to some other factor, namely the waning of supply-side shocks as energy prices retreated and global supply chains normalized.

To be sure, the Fed’s rate hikes likely helped bring the inflation rate down. 

But, as even Powell himself has suggested (such as in his recent speech at the Fed’s annual Jackson Hole Economic Policy Symposium), the timing does not support the story of tight policy delivering a quick cure.

The second reason to consider rate cuts now is equity. 

One thing we know for sure about inflation is that it hurts the poorest in society the most. 

As we explain in Inflation: A Guide For Users and Losers, this is because lower-income households spend a greater share of their earnings on consumption goods such as food, rent, and energy than wealthier households do.

But when interest rates went up, lower-income households were hit again, this time through higher mortgage rates, larger credit-card payments, auto-loan delinquencies, and a greater risk of unemployment. 

Evidence from the Federal Reserve Bank of New York shows that delinquencies on auto and credit card loans have spiked most sharply among low-income borrowers since 2022, the year the Fed’s tightening began.

This double-whammy effect on low-income households increases inequality. 

Using IRS data across US metropolitan areas, research from the Federal Reserve Bank of Boston shows that an unexpected 25-basis-point rate hike raises labor-income inequality by about 0.75% per year on average, cumulating to roughly 3% over four years. 

This effect is driven mainly by falling wages at the bottom decile, proving that Fed tightening disproportionately hurts low-income workers. 

In other words, the policy cure (higher interest rates) compounded the disease (inflation) for the most vulnerable.

For these reasons, lowering interest rates is not necessarily a bad idea. 

But instead of a discussion about the social costs of high rates, we have gotten a political battle over the Fed’s independence. 

The danger now is that, by making rate cuts look like political capitulation, the administration puts the Fed in an impossible bind: either resist and risk more pain for those at the bottom, or comply and signal that the central bank might be buckling under political pressure.

Mark Blyth, Professor of International Economics and Director of the Rhodes Centre for International Economics and Finance at the Watson Institute for International and Public Affairs at Brown University, is the co-author (with Nicolò Fraccaroli), most recently, of Inflation: A Guide for Users and Losers (W. W. Norton & Company, 2025).

Nicolò Fraccaroli, an economist at the World Bank and a visiting scholar at Brown University, is the co-author (with Mark Blyth) of Inflation: A Guide for Users and Losers (W. W. Norton, 2025).