Why Progressives Want Lower Interest Rates, Explained

Despite large declines in inflation, a much cooler job market, and rising pressure from groups across the political spectrum, the Federal Reserve has maintained interest rates at a range of 5.25–5.5 percent since July 2023. The Fed first began rapidly increasing federal funds rates—the interest rates banks and other financial institutions use when they loan money to one another—in March 2022, starting from a range of 0–0.25 percent and reaching the current  range in July 2023. Following financial market volatility earlier in August 2024, calls to reverse these hikes have become louder and broader as investors and businesses aggressively join economists and advocacy groups across the political spectrum in the effort. The consensus is clear: Interest rate cuts are long overdue.

While some reasons to cut rates, such as preserving labor market gains, are tied to the current economic outlook, further delay in cutting rates risks harming the long-term health of the economy. Maintaining high interest rates when inflation is already under control is likely to stifle economic growth; weaken worker power; restrict investments, particularly in housing and green infrastructure; and harm emerging economies around the world. Finally, while the strong recovery from the COVID-19 economic crisis has allowed the Federal Reserve to move away from the zero lower bound for the first time in decades, keeping rates artificially high is neither necessary nor a sustainable way to preserve room for future expansionary rate cuts. 

At the same time, caution is warranted. Interest rate policy has limited ability to fine-tune the economy and operates with delayed impacts. The Fed should avoid cutting rates by too much, or achieving and then maintaining perpetually low interest rates—especially in the absence of coordinated macro fiscal stabilizers like automated spending increases in anti-poverty programs or delivery of stimulus checks during recessions. Hyper-low interest rates can  disproportionately benefit the wealthy and could inflate asset bubbles in markets like real estate and stocks in the short run. Cuts are needed, but the blunt tool of interest rate changes should be used with care.

Why We Need to Cut Interest Rates

Inflation is largely under control. The argument for maintaining high interest rates often hinges on the need to control inflation. However, in the current economic climate, this rationale seems increasingly outdated. Inflation has largely returned to acceptable levels, so there is no data-driven rationale for keeping interest rates high. In fact, as Joseph Stiglitz and I have argued before, most of the inflation reduction we’ve seen over the past year is a result of supply chain adjustments rather than adjusted demand-side pressures, making the need for the Fed’s initial rapid tightening with higher rates—and continued tightening—questionable. The rapid increase in rates was already a generalized overreaction to a specific set of problems, and now is the time to correct course—especially as we expect more labor market cooling in the pipeline given the lags with which monetary policy operates.

Labor market gains are dissipating and must be preserved. After a period of historically low unemployment, reaching a lowest rate of 3.4 percent in April 2023, the unemployment rate has inched back up, hitting 4.3 percent in July 2024. Simultaneously, while 2022 and 2023 saw unprecedented gains in real wages, nominal (and real) wage growth has slowed, as has the deceleration in inflation. Real average hourly earnings are still positive, but increased only by 0.1 percent from June to July 2024, compared to 0.4 percent from May to June 2024. The most recent jobs report and concurrent downward revisions have also strengthened the case for cuts, as the number of jobs added fell to 114,000 in July 2024. The current levels of these indicators aren’t alarming, but the trajectory set by high rates and the unnecessary rise in unemployment are concerning. At this point, keeping the federal funds rate high has begun to erode and will continue to erode the labor market. By lowering interest rates, we could lower borrowing costs, encourage businesses to expand and hire more workers, and ultimately preserve the labor market gains achieved over the past two years. 

Housing supply needs to grow. Even as overall inflation has fallen to 3 percent in July 2024, shelter inflation still remains at 5 percent—higher than pre-pandemic levels—and continues to drive a significant part of consumer price inflation. High interest rates tend to suppress housing construction, keeping supply low and increasing housing costs. Lower interest rates would make borrowing more affordable, potentially increasing housing development and making homeownership more accessible. This could help alleviate some housing market pressures, making it easier for people to buy homes.

Investments in physical infrastructure and the climate transition need a boost. The restrictive impact of high interest rates on economic activity varies across sectors, as some are more credit-dependent than others. Sectors requiring higher upfront capital, such as housing, intangible investments, and investments in physical plants and equipment, are disproportionately suppressed. Green investments, known for their higher upfront and lower operating costs, are likely to be more restricted than other investments. Additionally, investments in the large infrastructures necessary for supply chain resilience, such as equipment, ports, and shipping, are also likely to face greater restrictions. Ironically, these are the very sectors that need an investment boost to better prepare for supply chain disruptions, which can cause severe price shocks such as those seen during the COVID-19 pandemic.

Emerging economies are suffering from higher interest rates set by the US. High interest rates have increased the debt-servicing costs of many economies and triggered capital outflows, exacerbating global inequality. Lowering interest rates would help address the negative effects of US domestic policy on our allies.

Timing and Pace Matter

The time to cut is now. Monetary policy operates with a lag, meaning the effects of interest rate changes take time to permeate through the economy. Even with rate cuts now, the economy will still feel the lingering effects of previous hikes. This means that maintaining high rates will lead to further unnecessary overcorrections in the future, whereas implementing small reductions from current levels now can support the labor market, stimulate growth, and address housing supply issues. 

However, as necessary as rate cuts are right now, too-low interest rates may lead to economic distortions that can hurt economic growth, make it harder to deal with future recessions, and exacerbate inequality, especially in the short run. Inequality in our economy results from various complex factors, but in the short run, wealthier individuals with assets like stocks and real estate benefit from inflated asset prices thanks to low rates, while those without such assets see fewer gains. This does not mean that zero or near-zero interest rates always create an atmosphere of “free money” that necessarily results in risky business decisions and asset bubbles that disproportionately benefit the wealthy—but the potential is there. There are risks and uncertainties associated with the impact of low interest rates that we must approach with care.

Most importantly, without support from policies like automatic fiscal stabilizers, a low–interest rate environment will limit the central bank’s ability to respond to future economic downturns.  With less room to cut rates further, the central bank’s monetary policy tools become less effective in stimulating the economy during recessions, when they’re most needed. In a political-economy climate where the execution of crucial fiscal policy relies on political will and potential bipartisan support, the option to use monetary policy to deal with recessions becomes even more important. 

In July, the three-month moving average of the national unemployment rate rose by more than 0.5 percentage points relative to its lowest point during the previous 12 months. This triggered the Sahm rule, an indicator based on the national unemployment rate that identifies the potential start of a recession. Paired with news of volatilities in the financial market, the triggering of the rule has panicked the economic news cycle. But as Claudia Sahm—the economist whom the rule is named after—put it, the rule “is a historical pattern, not law of nature.” It is important to note, therefore, that this moment does not mean we are in a recession yet: In fact, we are not. While some of this urgency appropriately reflects the need for a rate cut, in the process, it also overemphasizes the role of monetary policy in achieving a precise and well-rounded effect on the economy and de-emphasizes the danger of hyper-low rates in the long term. 

The economy is and should be influenced by a wide range of policies. While monetary policy is a vital tool, it is a rather blunt instrument that works with little precision and requires a thorough understanding of the changing sensitivities of different sectors to interest rates. However, although there are necessary debates about the channels of transmission and efficacy of monetary policy in improving the overall health of our economy, there is no doubt that a lower interest rate is long overdue. Cutting the federal funds rate is the appropriate and necessary policy response to the condition we find ourselves in: a relatively cooler labor market and controlled inflation scenario.