Federal Reserve to Cut Interest Rates for the First Time Since 2020

The U.S. Federal Reserve is expected to cut interest rates on Wednesday, in a move that represents significant economic progress. The rate will likely be cut by either 25 or 50 basis points, with the specific amount to be decided during this week's Federal Open Market Committee (FOMC) meeting scheduled for September 17-18.

The Road to Recovery

The Fed's decision comes as inflation reaches its lowest point since February 2021, currently sitting at 2.5%. Interest rate hikes, not cuts, have been the norm in recent years; the Fed increased rates 10 separate times between March 2022 and June 2023. The decision to cut rates represents a key step on the path toward normalcy, with the result likely being stimulation of key sectors.

Inflation peaked at 9.1% in June 2022, shortly after interest rates had initially been raised. At that point, it was the main priority of economic decision-makers to discourage unnecessary borrowing and cut inflation. Now, with concerns of inflation subsiding, the goal appears to be the opposite: to encourage borrowing, spending, and investing in the pursuit of economic growth.

Keeping Momentum

Decreased interest rates will undoubtedly stimulate the economy. This is because of the implications for borrowing and investing. When rates are lower, more people can justify borrowing more money. With more money circulating, big purchases like cars and houses increase. This leads to increases in production (GDP) and often creates jobs.

Low interest rates have a significant impact on company investment. As borrowing prices fall, corporations find it easier to borrow money for expansion, technology upgrades, and infrastructure projects. This rise in business investment boosts productivity. Businesses that expand and thrive as a result of these investments create more jobs, raising aggregate demand and improving economic momentum. Furthermore, reduced interest rates can encourage innovation by encouraging businesses to innovate in ways that were previously thought too risky or costly. This increase in economic activity can maintain a substantial rebound and long-term growth, making interest rate cuts a vital step toward a full economic recovery.

A Vital Balance

While the opportunity to stimulate the economy is certainly exciting, regulators ought to be careful. Excessive interest rate cuts are known to be dangerous. For one, they can re-ignite inflation, putting our economic recovery in reverse. At worst, they can over-encourage careless investment, leading to the formation of economic "bubbles." Many economists believe that excessive interest rate cuts during the early 2000s created the conditions that led to the housing market crash of 2008. 

In addition to the risks of inflation and economic bubbles, there are other potential pitfalls associated with aggressive interest rate cuts. Such measures can undermine the stability of financial institutions by compressing their profit margins, particularly for banks that rely on the spread between deposit and lending rates. This might result in less money available for lending, which would eventually hinder rather than encourage economic progress. Furthermore, extended low interest rates may encourage consumers and businesses to borrow excessively, resulting in unmanageable debt levels that could cause major issues in the future. To effectively deal with the obstacles of economic recovery, authorities must carefully balance the needs for growth and financial stability. 

This is where the importance of tomorrow's meeting lies. Federal Reserve decision-makers will discuss not only Wednesday's decision but also the direction of their policies for the near future. 

It is presently unclear how the Federal Reserve will act toward interest rates moving forward. Although cutting rates now likely entails further cuts in the future, this is not guaranteed. Federal Reserve decision-makers will closely monitor the impact of their decision on inflation, investment, and the overall economy and use what they learn to guide their proverbial path.