Here are three reasons why a Fed rate cut won’t save Wall Street

Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, D.C., U.S., on Wednesday, Jan. 30, 2019.

Al Drago | Bloomberg | Getty Images

As President Donald Trump’s trade wars rattle investors, Wall Street has reached for a security blanket: new Federal Reserve rate cuts to offset the economic damage.

But senior economists from both political parties say it may not work that smoothly even if the Fed says yes, for three reasons. And that poses risks to America’s decade-long recovery as the 2020 presidential election draws nearer.

The first is that tariffs and tariff threats have shaken confidence among trading partners and businesses, as shown by the Business Roundtable’s eroded second-quarter CEO Economic Outlook Index. Demand-side stimulus from Fed rate cuts can counter contractionary effects of tariff costs, but not the harm to the animal spirits of corporate America.

Monetary policy can “modestly help” but “is not an ideal tool,” says Glenn Hubbard, dean of Columbia University’s Graduate School of Business. “That negative effect from policy uncertainty is likely to remain even if the present disputes with China and Mexico are resolved. This uncertainty is blunting part of the investment gains that were made possible by corporate tax reform.”

The second, more concrete reason is actual disruption to existing business patterns. Trump boasts that his tariffs have imposed a price on China by causing firms to leave, but that imposes costs on those firms as well.

“There are important supply-side effects as global supply chains become broken that cannot be addressed with monetary policy,” notes Harvard’s Greg Mankiw. Like Hubbard, Mankiw once served as top economic adviser to President George W. Bush.

The third reason is lags in timing. The economic bug that tariffs induce can set in before the Fed’s medicine starts working.

“Rate cuts take about 12 months to have substantial impact,” explains Jason Furman, who chaired President Obama’s Council of Economic Advisers. “Tariffs could be much faster acting, so that could be a real problem for the economy in the second half of 2019.”

Economists expected a 2019 slowdown even before Trump declared himself “a tariff man” last December and set about proving it. After a burst of stimulus from the late 2017 GOP tax cuts, growth tapered in the latter months of 2018 and fell short of the administration’s full-year projection of 3% or higher.

The surprising 3.1% growth from the first quarter of 2019, driven partly by inventory accumulation, raised hopes of a more robust year. But job growth has declined, with forecasters projecting growth around 2% or lower in both the second and third quarters of 2019.

“The question is whether this is a natural settling of the business cycle…or are the trade wars wreaking some havoc on the economy,” observes Betsey Stevenson, another former Obama adviser. “I tend to think that there is evidence that the latter is happening.”

The result: rising fears that the economy will not just grow more slowly but instead actually shrink. Vanguard’s chief economist this week raised the odds of recession within the next 12-18 months to 40%, up from 30% previously.

“The economy is on a razor’s edge,” says Mark Zandi of Moody’s Analytics. “Growth has slowed significantly from last year and is close to stalling out. And it will if the president doesn’t stand down soon.”

Douglas Holtz-Eakin, former head of the Congressional Budget Office, calls the trade war “damaging” but still considers it “premature” for the Fed to act. Cutting rates now to offset Trump’s tariffs would narrow the central bank’s maneuvering room for responding to a more ominous setback such a global energy price shock or debt crisis.

“The idea that the Fed has only a little bit of room left to ease policy if something else goes south,” warns Justin Wolfers, a Democratic economist at the University of Michigan, “should be terrifying.”

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