Anthony Behar/Sipa USA via AP Images
Prices for consumer goods, including groceries, are down.
The latest news on the price stability front is unambiguously good. The latest Consumer Price Index (CPI) report for June came out Thursday, and it showed a monthly decline compared to May of 0.1 percent. The previous report had prices flat month-on-month. Under the hood, the news was also good: Rents and home prices are stabilizing, along with grocery prices. Inflation on services remains elevated, but goods are downright deflationary at the moment.
Incidentally, this is yet further proof that neoliberal economists like Larry Summers and Jason Furman were completely wrong that beating inflation would take driving unemployment to 10 or 15 percent (their two predictions, respectively). They may have predicted that inflation would happen, although their reasoning was faulty; they assumed it was primarily due to overspending rather than the supply chain disasters of the post-pandemic period. This error led them to be catastrophically wrong about how to fix the problem.
I could fight that old battle all day long, but it’s time for a new one: Federal Reserve Chair Jerome Powell must cut interest rates. Here’s why.
As my colleague David Dayen noted on Wednesday, while the economy remains exceptionally strong by historical standards, there are signs of growing weakness in the labor market. Unemployment has inched up from 3.4 percent in April of last year to 4.1 percent in June. Job openings have fallen from about 13 million in April of 2022 to about eight million in May. Nominal wage growth is down from about 6.7 percent to 4.7 percent over the same period.
So first, it’s critical for the Fed to stay ahead of the recession curve. Rising unemployment rates have a strong tendency to snowball out of control into a recession, a pattern clearly visible in the data. When people get laid off, they lose income and cut back on their spending, leading to reduced income at nearby businesses and more layoffs, and so on. But interest rate changes take months or even years to have an effect. If the Fed dithers on rate cuts—as it has for the last five months of steadily calming inflation—it risks being too late to head off a recession before it gathers momentum.
Second, interest rate effects are concentrated in industries that are sensitive to interest rates, particularly home construction. This is important because despite softening rents and home prices, the United States remains grievously underhoused. Thanks to the collapse of the homebuilding industry after the financial crisis, the number of new home starts per capita fell to the lowest level in 60 years, stayed there for half a decade, and then crawled back up agonizingly slowly. By mid-2022, it had finally reached something approaching normal, but not remotely a boom. The most recent peak was less than half that of the 1970s—nowhere even close to the levels necessary to make up for the previous lost decade of construction.
The Fed’s interest rate hikes have badly dented the home construction market, because it is now much more expensive to finance that activity.
That lost decade is a major reason why both home prices and rents spiraled out of control in many cities over the last three years. Millions of people newly flush with pandemic savings and rescue money after the terrible economy of the 2010s wanted more space, and millions more needed offices to work from home. With supply of homes short, that turned into a bidding war.
But the Fed’s interest rate hikes have badly dented the home construction market, because it is now much more expensive to finance that activity. Sure enough, starting in April 2022 as rate hikes started to bite, new private home starts have fallen by about 30 percent, to about where they were in 2018-2019. It’s also more expensive for homebuyers: Mortgage rates have more than doubled compared to 2020.
When it comes to housing, the Fed’s interest rate tool works directly at cross-purposes. On the one hand, rising rates do cool housing costs by impoverishing some portion of the population such that they can no longer afford a new house or apartment, but on the other it crimps the supply pipeline of homes, pushing upward on prices. Neither of those are great outcomes. We badly need to get home construction back on track so shelter is both plentiful and affordable—and now that inflation is flat, we can help it happen by cutting rates.
Third, another vital industry extremely sensitive to interest rates is renewable energy, above all offshore wind. Given that solar and wind have no fuel costs, their price is heavily influenced by the cost of financing the capital investment. Solar is so cheap that it’s still going gangbusters (though it might go even faster with lower rates), but wind has been hit hard. New installed wind capacity was up just 6 percent in 2023, the smallest increase in a decade, and wind power generation actually fell, thanks also to unusually calm winds. The Fed’s rate hikes, along with inflation, killed several major offshore wind projects off the coasts of New Jersey, New York, Massachusetts, and Connecticut, which had been a vital component of those states’ climate goals. They may be resurrected, but the future is unclear.
Now, renewable energy is not in the Fed’s formal policy wheelhouse, but it simply can’t be denied that it holds enormous sway over the industry. Fueling the green-energy transition is by far the most important policy priority in the country—to help head off climate change, to cut the deadly air pollution released by coal and natural gas power plants, to protect national security. And to ensure that the U.S. gets a piece of the greentech industry that is going to drive the global economy for the next several decades.
In fact, the Biden administration committed to hundreds of billions of dollars in spending through the tax code to build green-energy sites and cleantech manufacturing plants for things like electric vehicles. What the Fed is doing now with high interest rates is blunting that progress, effectively nullifying a top priority of the legislative and executive branch. Even if Fed members can’t admit it outright, they still have a duty to act.
It’s time for Jerome Powell and the Fed to declare victory. They did it—maybe somewhat by accident, given how many price increases were due to one-off pandemic disruptions not related to interest rates—but it’s still a win. We got the soft landing. America’s economic airplane is on the ground. Let’s not now crash it into the terminal.
