Understanding Interest Rate Policy

When rates should rise or fall

Last week Mike Johnson, the speaker of the House, said something stupid. OK, that has been true every week of Johnson’s tenure. But this particular remark was right up this newsletter’s alley and suggested the topic for this week’s primer.

Here’s what happened: Johnson went on TV and supported Donald Trump’s demand that the Federal Reserve cut interest rates. Why should the Fed cut? Because, said Johnson — echoing Trump — “the American economy is hot.”

That sound you hear is thousands of economists slamming their heads on their desks. Interest rate cuts aren’t supposed to be a gold star the teacher gives you when you did well on a quiz. Interest rates are a tool for managing the economy — and a hot economy is a reason to raise rates, not cut them.

But I’m not sure how many people, even among those generally well-informed about public affairs, understand why economists say that. And I’m sure that relatively few people who aren’t economists know either how events and ideas led to the current consensus about interest rate policy or why there are real arguments among serious, non-MAGA people about the Fed’s next move.

So this week’s primer is about interest rate policy. Beyond the paywall I will discuss:

1. Why the Fed matters

2. The (controversial) tradeoff between unemployment and inflation

3. The long search for monetary rules

4. Post-Covid conundrums

5. What is Trump thinking?