Reagan Advisor Argues Against More Fed Rate Cuts

Any additional interest rate cuts by the Federal Reserve would be counterproductive, spurring commodity price inflation without helping the economy, according to Martin Feldstein, former chairman of President Reagan’s Council of Economic Advisors.

The Fed has slashed the fed funds rate by 300 basis points to 2.25 percent since September 2007. Feldstein, now an economics professor of Harvard, writes in The Wall Street Journal that the normal worry about rate reductions is that they will spark economic growth to the point that wages and prices on goods and services rise.

That’s not a concern in the U.S. now, because the economy is weak enough to prevent prices and wages from increasing much, Feldstein says. But lowering rates will spark even further increases in prices of commodities such as food and energy, he argues.

Already this week, crude oil reached a record high above $114, and the Labor Department reported that producer prices soared 1.1 percent in March.

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"Lower interest rates add to the upward pressure on commodity prices by making it less costly for commodity investors and commodity speculators to hold larger inventories of oil and food grains,” Feldstein writes.

"Lower interest rates induce investors to add commodities to their portfolios,” as they search for higher returns.

To be sure, Feldstein acknowledges that other developments are boosting commodities prices as well. "Many factors have contributed to the recent rise in the prices of oil and food, especially the increased demand from China, India and other rapidly growing countries,” he writes.

Still, lower rates clearly play a role, Feldstein maintains.

And rising food and energy prices already have caused riots in developing countries, he notes. "In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates.”

That wouldn’t be a positive development, Feldstein points out. "Such contractionary policies would reduce real incomes and exacerbate political instability.”

With food and energy prices comprising 25 percent of the U.S. consumer price index, commodity price increases would boost U.S. inflation too, Feldstein writes. The CPI already has jumped 4 percent over the past year.

And aside from sparking inflation, lower rates won’t accomplish the Fed’s intended goal of stimulating the economy, Feldstein contends.

"The current conditions in the housing industry and in credit markets mean that a further lowering of interest rates will have a smaller impact on demand than in previous recessions,” he writes.

"In previous recessions, lower rates stimulated aggregate demand by inducing increased home building. But with the massive inventory of unsold homes — up 50 percent from a few years ago — a further cut in the fed funds rate would have little effect on housing construction.”

During the Fed’s massive rate cuts of the past seven months, mortgage rates have barely budged, slipping less than 0.5 percentage point, Feldstein notes.

"The dysfunctional state of the credit market means that many individuals and businesses are unable to get credit. Lowering interest rates will not stimulate demand for those who cannot get credit.”

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