The economy is strong. Unemployment is historically low. Consumer confidence is high. So why, exactly, did the Federal Reserve cut rates Wednesday?
One argument: By cutting rates, the Fed could grow the supply of money, which has been growing too slowly for the past few years. That, more than any tool at the Fed’s disposal, will help keep the economy growing.
“Everyone is focused on interest rates, and that’s the wrong thing to focus on,” said Steve Hanke, an economics professor at Johns Hopkins and a director of the Troubled Currencies Project at the Cato Institute. “It’s all about the growth in the money supply. That’s what drives changes in nominal GDP.”
The number of notes and coins in circulation plus bank accounts is growing at 4.8% per year. Although that’s up from its low of 3.5% per year in October, “a bit more would probably do some good,” Hanke argued.
He argues that the economy is not overheating, which gives the Fed wiggle room to loosen its grip on monetary policy ahead of “international storm clouds” on the horizon — which include uncertainty about trade, a potential no-deal Brexit and slowing growth in China.
Hanke said the US-China trade war and an increase in tariffs, in particular, could damage the global economy, backfiring on the United States.
“The US thinking on this thing is completely wrongheaded,” Hanke said. “We have a president who is a businessman and most businessmen have no clue about international economics.”
Policymakers led by Fed Chairman Jerome Powell voted 8-2 in favor of a small cut in the federal funds rate on Wednesday, and recommitted to their promise to “act as appropriate” to sustain the country’s longest economic expansion in history.
Cutting rates would weaken the dollar, potentially making US exports more attractive to foreign buyers. That’s why the Trump administration has been advocating for devaluing the dollar.
But Hanke cautioned against any intervention on the part of the Trump administration.
“Unilateral interventions are useless unless they’re well planned and well coordinated, otherwise you’re just burning up foreign currencies,” he warned.
