For the first time since 2020, the Federal Reserve announced Wednesday that it will cut interest rates by a half percentage point, bringing the benchmark federal-funds rate to a range of 4.75% to 5%. This decision, supported by 11 of 12 Fed voters, marks a significant shift after a period of aggressive action to combat inflation.
“I think that's well within reason,” said John Diamond, the Edward A. and Hermena Hancock Kelly Fellow at Rice University. “I think that there were good arguments for 25 and 50 basis points. Personally, I like starting with 50. If you really think the labor market is struggling, there's no need to mess around and get yourself behind the eight ball any more than you already are.”
The rate cut reflects growing confidence that inflation is steadily declining toward the Fed's 2% target, while concerns about weakening labor market conditions loom. The unemployment rate reached 4.2%, up from earlier this year, prompting the Fed to act decisively to prevent further economic slowdown.
“I think the half point cut (and chair Powell’s statements) clearly signals that the Fed is concerned about weakness in the labor market,” said Zach Bethune, associate professor of economics at Rice. “The thinking is likely that it’s better to cut more strongly now than having to do it in the future.”
The rate reduction is expected to offer relief to consumers and businesses facing variable-rate debt, as borrowing costs have already begun to decline.
“Monetary policy always acts with a lag,” Diamond said. “It's going to take a bit for interest rates to adjust and for this to start figuring into the calculus of consumer's decisions. It'll be slow at first and build overtime, but it will definitely begin to have a positive impact over the next month or two, benefiting consumers and firms that are looking to invest in capital.”
Fed projections suggest further cuts could occur in November and December if unemployment remains stable and inflation continues to cool. Despite political pressure from both sides, Fed Chair Jerome Powell emphasized the decision was guided by economic data rather than politics.
“I expect consumer loan rates to fall relatively quickly on mortgages, car loans, credit cards, etc.,” Bethune said. “The Fed hopes it will also lead to higher real wage growth in the short run, but that connection is murkier.”
Bethune is an associate professor of economics, specializing in macroeconomics and finance. His research explores the distributional effects of inflation and the influence of private information on financial market trade.
Diamond, director of the Baker Institute for Public Policy’s Center for Public Finance, adjunct professor of economics at Rice and CEO of Tax Policy Advisers, LLC., is currently focused on the economic effects of corporate tax reform, the economic and distributional effects of fundamental tax reform, taxation and housing values, public sector pensions, and various other tax and expenditure policy issues.
Bethune and Diamond are available to comment on the Fed’s interest rate cut. To schedule an interview, contact media relations specialist Brandi Smith at 713-348-6769 or brandi.smith@rice.edu.