WASHINGTON — With the nation’s unemployment rate at its lowest point since human beings first walked on the moon, you might expect the Federal Reserve to be raising interest rates to keep the economy from overheating and igniting inflation.
That’s what the rules of economics would suggest. Yet the Fed is moving in precisely the opposite direction: It is widely expected late this month to cut rates for the third time this year.
Welcome to the strange world that Jerome Powell inhabits as chairman of the world’s most influential central bank. Though unemployment is low, so are inflation and long-term borrowing rates. Normally, all that would be cause for celebration. But with President Donald Trump’s trade wars slowing growth and overseas economies struggling, Powell faces pressure to keep cutting rates to sustain the U.S. economic expansion.
“It’s a very hard position for the Fed to be in,” said Diane Swonk, chief economist for consulting firm Grant Thornton.
One illustration of the Fed’s unusual dilemma: The unemployment rate is now 3.5%, the lowest level since 1969.
The Fed’s benchmark short-term rate stands in a range of just 1.75% to 2%. By comparison, the last time unemployment fell below 4% — in 2000 — it raised its key rate to 6.5% to try to control inflation, which normally rises as unemployment falls. Having its benchmark rate that high also gave the Fed room to cut rates once a recession hit the next year.
Today’s economic landscape is dramatically different. The same forces that are depressing growth and inflation and limiting pay growth are also boxing in the Fed: Slowing population growth and sluggish worker productivity are restraining the economy’s ability to expand.
Online shopping, international competition and a more frugal consumer have held down inflation. A weak pace of growth and undesirably low inflation have forced the Fed to keep borrowing costs historically low. Once a downturn inevitably strikes, the Fed will have little ammunition left in the form of further rate cuts.
Persistently low interest rates are “the pre-eminent monetary policy challenge of our time,” Powell acknowledged in June.
In response, the Fed has embarked on a far-reaching review of its monetary strategy and tools, which includes a series of public consultations known as “Fed Listens.” Its initiative is a tacit acknowledgement by the Fed of its peculiar economic quandary.
“Fed Listens” sessions have been held by nearly all of the Fed’s 12 regional banks. The sessions, attended by high-level bank staffers and sometimes Powell himself, have included labor advocates, community groups and academics specializing in worker training and education. The Fed says it will announce any changes to its strategies in the first half of next year.
One likely change, Fed watchers say, is the adoption of an average inflation target that the Fed would aim to achieve over time. Since 2012, the Fed has set an annual target of 2%. But it hasn’t always been clear whether that is a ceiling or a more flexible goal.