Big rate cut forces US Fed to contend with new obstacles

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Subscribe to enjoy similar stories. Fed Chair Jerome Powell entered a new phase in his campaign to softly land the U.S. economy, lowering interest rates Wednesday with an audacious half-point cut.

The move raised new questions the central bank can’t easily answer. At the same time, the rate cut did clarify the answer to a more important question about the Fed’s overarching goal. It underscored Powell’s desire to prevent the central bank’s past rate rises from tipping the economy into recession now that inflation is heading down.

But chief among the questions the Fed can’t easily answer now that it is cutting: Where is the Fed taking rates and how fast will it get there? The Fed doesn’t know on either front. Officials often set policy with an eye toward figuring out where their interest rate is relative to a so-called neutral rate that neither spurs nor slows growth. The neutral rate can’t be observed.

Before the pandemic, most Fed officials thought this neutral rate had fallen to 2.5% or lower. Now, many think the rate has risen, thanks in part to soaring government deficits. Powell characterized the Fed’s latest cut, which lowered the benchmark federal-funds rate to between 4.75% and 5%, as “recalibrating policy down over time to a more neutral level." While he has typically avoided offering specific pronouncements about where that might be, he volunteered on Wednesday that “the neutral rate is probably significantly higher than it was" before the pandemic.

“How high is it? I just don’t think we know," Powell said. How fast the Fed cuts is also a wild card, and Powell tried to dissuade investors of the view that a half-point cut should be the default path at the central bank’s next meeting in November. “There’s no sense