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The Federal Reserve cut rates for the first time in a decade on Wednesday. With US growth solid, the move has invited speculation: Might the Fed be appeasing Donald Trump, who routinely blasts the central bank for too-tight rates?
It’s an ominous possibility. One of the most sacred tenets of economics is “central bank independence”—the immunity of monetary policy to politics. And with good reason; state pressure has ignited past inflationary episodes (most notoriously during Richard Nixon’s 1972 reelection campaign).
Regardless of its causes, 1970s-style inflation would indeed be frightening. Also scary, though, is the prospect that freakishly low inflation might not budge—a sign that what ails the US economy is beyond the Fed’s powers to heal.
Usually, low inflation signals that people are buying less than the economy can produce—causing rising unemployment and slumping output. Cutting rates encourages borrowing, funding new spending that reverses things. Eventually, businesses and workers are so flush, they start demanding more than the economy can produce. Prices climb. To curb inflation, the central bank hikes rates back to where they had been.
That was the business cycle of the 1950s through the 1970s. No longer.
Despite a decade of ultra-low rates and unconventional monetary policies, inflation refuses to budge—hinting at an economy operating at less-than-full capacity. So the Fed kept rates low (though in fairness, it tightened more than other central banks). That helped the economy—but also fueled a corporate debt binge. Credit now rivals earnings as a critical growth engine—for example, between 2015 and 2017, as much as 40% of business investment (pdf) came from companies financed by junk bonds. That leaves the real economy increasingly hooked on Fed liquidity.
This brings us to the Fed’s big dilemma. Weak global growth and Trump’s trade warring threaten to drag down growth. Preventing mass corporate default requires loose money. Given those conditions, Wednesday’s cut might indeed keep things stable—and maybe even revive inflation. Then again, the economy is already clogged with debt. That makes it harder for cheaper credit to pump up demand and, therefore, prices. And, of course, adds to the costs that eventually must be paid to unclog it. —Gwynn Guilford
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Our best wishes for a relaxing but thought-filled weekend. Please send any news, comments, AV scenarios, and all-purpose cleaning tablets to firstname.lastname@example.org. Join the next chapter of Quartz by downloading our app and becoming a member. Today’s Weekend Brief was edited by Steve Mollman and Kira Bindrim.