Federal Reserve Chairman Jerome Powell said on Wednesday that the era of ultra-low interest rates that lasted from the 2008 financial crisis through the pandemic is likely over, and that the neutral interest rate for achieving 2% annual inflation has probably risen.
Testifying before the House Financial Services Committee, Powell said the central bank's interest rate policy is unlikely to return to the near-zero level it was at from 2009 to 2017, despite significant progress in fighting inflation.
“We're probably not going to go back to the days between the global financial crisis and the pandemic when interest rates were very low and inflation was very low. Extremely low,” he said. “I don't think we're going to see interest rates go back to that low.”
Powell said the Fed's benchmark interest rate, needed to achieve the central bank's “dual mandate” of low unemployment and price stability, probably rose in response to pandemic-induced inflation and the subsequent normalization of prices.
“We think that things like the neutral rate are driven by slow-moving forces, but ultimately you see their impact. Right now, the policy rate is above 5 percent and we feel that policy is tightening but not extremely tight. This suggests that, at least for now, the neutral rate has risen somewhat, which means rates are due to rise a little more,” he told the committee.
Investors have been eagerly awaiting interest rate cuts from the Fed, and while most market participants see rate cuts as having a stimulative effect on the economy, there has been recent speculation that higher interest rates may actually stimulate economic activity through interest income.
A recent rise in the unemployment rate and declines in the two main measures of inflation, the personal consumption expenditures price index and the consumer price index inflation, suggest the Fed may soon start cutting interest rates.
“Recent monthly data suggest further moderate progress. Longer-term inflation expectations appear to remain anchored,” Powell said, adding in later testimony that rates should be cut before price momentum drives inflation down to 2%.
Whether the cut comes later this month, in September or later this year, Powell's comments on the longer-term neutral rate on Wednesday suggest that investors shouldn't expect a reciprocal decline in interest rates to offset the rapid tightening cycle that began in March 2022.
The fiscal situation in the economy, which may be behind some of the “slow-moving forces” responsible for potential changes in the neutral rate, is very different than it was before the pandemic.
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These include the ballooning national budget deficit, which reached a new level of about 120% of gross domestic product in the pandemic's aftermath, and massive private sector loans and tax credits (still being processed by the IRS) that helped businesses survive during the pandemic.
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