What if the Fed doesn’t cut spending?

The Fed is widely expected to cut rates in September. Nevertheless, Fed Chairman Powell emphasizes that the decision will depend on data. Suppose the Fed decides not to cut rates in September – what does that mean for growth prospects for the fourth quarter of 2024? Should that mean we have to adjust our forecasts, or should we increase the growth forecast?

Here the answer depends on whether you are making a conditional prediction or an unconditional prediction. Let’s start with conditional predictions:

Suppose that at the time of the September meeting, annual PCE inflation is about 2.5% and the Atlanta Fed continues to forecast that real GDP will grow 2.8% in the third quarter (which is the current forecast is). Under those circumstances, a Fed rate cut would likely lead to faster economic growth expectations than a decision not to cut rates.

Now let’s look at an unconditional prediction. Would I expect faster economic growth after an interest rate cut, or after a decision not to cut rates? Probably the latter. That’s because the Fed would only refrain from cutting rates in September if the economy showed significantly more momentum than currently expected. A decision not to cut rates would likely reflect an unexpected change in the trajectory of the economy. If I only knew that the Fed had chosen not to cut rates, I would increase my forecast for fourth-quarter GDP growth.

This is one reason why I don’t like talking about interest rates. When I hear experts predict a rate cut in September, I’m never sure whether they are making a prediction about the future path of monetary policy, or about the future path of the economy. I’d rather they tell me what kind of NGDP growth they expect over the next twelve months, but I almost never see those kinds of forecasts.