The big dumb lie that could wreck the American economy

In case you haven't noticed, there's a US presidential election this year. Given the importance of the election, it's no surprise that a number of conspiracy theories have popped up. In almost all cases, I have no more insight into the election than any average American citizen, but given my role as a business economist, there's at least one conspiracy theory I feel the need to confront head-on: that the Federal Reserve is trying to boost President Joe Biden's reelection chances.

After spending the past two years trying to get inflation under control by raising interest rates, the Fed is inching toward cutting rates soon. This policy shift has ignited claims that the Fed is "being political" because in standard economic theory, cutting interest rates would stimulate the economy, making it easier for businesses to get loans, invest, and hire. Rather than a nonpartisan response to the shifting sands of the economy, the theory claims, the reason for the coming rate cuts is that the Fed and its chair, Jerome Powell, hate former President Donald Trump and want to keep Biden in office. It's best to cut rates to boost the economy, improving voters' opinion of Biden heading into the 2024 elections, the thinking goes.

Right now, most of the commentary saying the Fed is trying to boost Biden is coming from former Trump administration officials or other Republican-leaning commentators, but that doesn't mean Democrats are immune from trying to politicize the Fed. Democratic Rep. Ro Khanna said the Fed needed to cut interest rates or Powell "may be the person most responsible for the possible return of Trump."

Regardless of which party is haranguing the Fed, it's important for Powell and the rest of the central bank not to look political. An apolitical independent central bank is a good thing for everyone because monetary policymaking free from political pressures will tend to result in a more stable economy. Setting interest rates should be about weighing costs and benefits for everyone, not engineering outcomes for a favored constituency. When people (usually those with a vested political interest) try to accuse the Fed of being biased, it erodes confidence. Don't fall for these lies: The accusation that the Fed is being political or trying to boost Biden's reelection chances has a few glaring problems.

Rate cuts, they just make sense

The first piece of the "Fed is trying to boost Biden" conspiracy theory is the idea that the central bank is suddenly reversing course on its inflation fight, as if Powell flipped on a dime as the election came into view. There's an easy way to check this idea: Every quarter, the Fed releases its Summary of Economic Projections, which breaks down the Fed governors' and board members' projections for GDP, inflation, unemployment, and the appropriate federal funds interest rate. These forecasts are conditional, not a set-in-stone promise of what the Fed will do, but they provide a useful picture of the various members' thinking about economic conditions at the time.

In the most recent summary, released in December, the Fed signaled that it planned to cut rates from 5.5% to 4.5% by the end of 2024. This was a change from the previous forecast, released in September, that estimated a 2024 year-end rate of 5%. The change was seen as a sign from the "Fed is political" camp that Powell et al. were laying the groundwork for more cuts, thereby boosting the economy for Biden. In fact, December's 4.5% projection was the same rate projected in June's Summary of Economic Projections — the September release was the aberrant one. Rather than suddenly reversing course, a sign of some sort of political motivation, the summary has consistently shown that the Fed members started projecting 2024 rate cuts in June 2022, roughly 1 ½ years ago.

Second, there's nothing special about recent revisions to the Fed's interest-rate projections. Inflation is slowing more rapidly than expected, and the US job market, while solid, has shown early signs of shakiness, so it stands to reason that the Fed would react accordingly.

While the unemployment rate remains low, it has ticked up somewhat from its recent bottom, and other labor-market indicators, such as the hiring and quits rates, have weakened in recent months. Given the signs we've seen from the economy, the Fed's adjustments to its forecast are pretty standard according to what's known as the Taylor rule. The rule says that as projections for inflation decrease, the Fed's forecast for its key interest rate should also go down. In the December Summary of Economic Projections, the Fed revised its projection for year-end 2024 core personal consumption expenditures inflation — the Fed's favorite gauge for inflation — downward by a total of 0.7 points. According to the Taylor rule, the Fed should have lowered its projections for the federal funds interest rates as well — and it did. A rule of thumb would be to cut interest rates by half the total revision to core personal consumption expenditures, so another 0.35 points off the federal funds rate, which is exactly what it did. Rather than some political conspiracy, the rate-cut forecast is just rules-based common sense.

The third reason the political-Fed idea makes no sense is that history suggests Powell and the other members are operating well within precedent. Our nearby table shows where unemployment and core inflation were at the time of the Fed's first interest rate cuts in the past. The unemployment rate was, on average, up 0.3 percentage points from its low, while core personal-consumption-expenditures inflation was running 2.5% at an annual rate in the three months leading up to the first cut. Where are we now? The headline unemployment rate stands at 3.7%, 0.3 points above its prior 12-month low, while core PCE inflation has climbed 2.16% at an annual rate over the past three months. That means core inflation is actually running somewhat below where it normally is when the Fed starts cutting. There's nothing abnormal about these cuts.

Also, it's not as if the Federal Reserve is acting alone. Several global central banks have already started cutting policy rates, and markets indicate that investors are already anticipating more rate cuts from the G10 (the 10 countries that represent the most traded currencies) central banks in the coming year. Are all these central banks bailing out politicians up for reelection? In many of these countries — Canada, the UK, Australia, and Japan — there are no national elections until 2025.

It's also worth noting that many of those accusing the Fed of being political have argued that there are "long and variable lags" to monetary policy, meaning that adjustments made to interest rates today will be felt in the economy 12 to 18 months from now. If that's right, then a political Fed should have already cut by now to guarantee that the effect of the cuts would be greasing the economy in time for the elections this fall.

Finally, for all the nonsense about "Biden appointees," or this being a Fed controlled by Biden, the very same Fed has shown itself to be apolitical. Some pushing the conspiracy theory point to an op-ed written by Bill Dudley in August 2019, shortly after leaving his post as the head of the New York Fed. In it, Dudley wrote that if the Fed boosted the economy by cutting rates, then the central bank would be implicitly enabling Trump's trade war — a move Dudley thought would be seriously misguided. It was a provocative piece, by Dudley's own admission, but his former colleagues seemed to ignore it: The Fed did end up cutting rates a couple of times. Cut to today, and the person who squeezed the toothpaste out of the tube, so to speak, was the Fed's governor Chris Waller, appointed by Trump. He's the one who publicly laid out the playbook: They're following a rules-based framework where changes in the rate of inflation translate to changes to their policy rate. It's also worth noting that the Fed is presently led by someone Trump himself nominated, Powell.

The real reason for the accusations

The entire conspiracy theory about a political Fed is weak on its face and baseless on its merits. The Fed's rationale for rate cuts makes perfect economic sense: Inflation is falling more rapidly than expected and there are enough signs of labor-market softening to start bringing down the federal funds rate. (There are, of course, reasons to debate whether cuts come with risks — such as overheating the economy later or if it makes sense to look at realized inflation over expected inflation, but that's not what this debate is about.)

In fact, those accusing the Fed of being political are being political themselves. The Fed's detractors want the economy to be weak because they have been negative about the economy, and it would help confirm their economic predictions or boost their employment prospects in a Republican administration. And rapidly cooling inflation makes it harder to use high prices as a political cudgel. Instead of accepting the economic reality as it is, they start from a conclusion first and work backward.

At any rate, all this complaining about the Fed's actions may not have much of an effect on the election's outcome: Conditions were worse leading up to the midterm elections of 2022, and by most accounts, Republicans were unable to capitalize on the situation. What makes anyone so sure they'll fare better in 2024 with the rate of inflation slowing, interest rates falling, and stocks rising?

There are reasons to be critical of the Fed. It may have eased too much during the pandemic. They may have been too slow to normalize policy. Those mistakes at least can be justified by faulty analysis — many people made the same mistake. However, accusing the Fed of being political is a different type of critique. In this case, it assumes the Fed has a political preference, which undermines confidence in the institution itself. And if the central bank loses credibility, no matter the reason, it would be seriously problematic for the US economy. Given that fact, it's important to reject baseless attacks on the Fed and recognize the coming rate cuts for what they are: an attempt to maintain low unemployment and stable inflation.

Neil Dutta is head of economics at Renaissance Macro Research.