Mickey Levy expects the Federal Reserve to do one more rate cut this year, not because it’s needed, not because it’s the right thing to do, and not because the majority of the Fed’s policymaking Federal Open Market Committee are forecasting at least one more reduction by the end of 2025.
He sees the Fed moving to cut its key rate again because it is misreading key signals from the economy. And he predicts that it may be one more cut and done for the FOMC this year as it realizes rate cuts are the wrong path.
Mickey, a monetary and fiscal economist who worked for many years in high profile positions on Wall Street, is a visiting fellow at the Hoover Institution and a long-standing member of the Shadow Open Market Committee, says we have to “think about the basics.”
“Inflation is generated when you have excess demand…for all goods and services relative to the production of those…and so when you look at nominal GDP , the broadest measure of aggregate demand, it’s growing…. 4.5% year over year,” he says. “If you think of productive capacity growing at 2% and aggregate demand growing at 4.5%, then that explains the inflation where we are now.”
Bottom line, Mickey says, “when you add everything up aggregate demand is still growing a little too fast to achieve that 2% inflation target.”
And just as important, he sees above-target and still- rising inflation as a sign that the Fed’s monetary policy is anything but restrictive.
What about the argument made by current and former Fed officials, along with many economists, that the Fed’s R Star estimates shows monetary policy is still at least mildly restrictive? Mickey explains why it is not restrictive at all, and points out that strong economic performance accompanied by inflation fail to support that idea.
He also dives into arguments made by the newest member of the Fed Board of governors and a Trump appointee, Steve Miran, who argues that R-Star is a fraction of what is being estimated now and is pointing to the need for a cut in the Fed’s key rate to 2%. Spoiler alert: Mickey says Miran’s supply-side model over estimates the impact of tax cuts and underestimates the effect of deportations on growth and inflation.
Volatile GDP requires averaging Q1 and Q2 for context 00:01:09:05
What you really need to do is average Q1 and Q2, because of the huge, widening of the trade deficit in Q1, subtracted (from GDP), the reversal added back (growth) in Q2. And what you get is continued, call it moderate growth in domestic aggregate demand. Consumption is growing. Okay. And the latest piece of data we got yesterday, you know, suggests that consumer spending continues at a healthy pace through August. Business investment is strong. The real weakness is housing that, as we know, is being affected by the high prices combined with, with mortgage rates.
But the economy’s, you know, continuing to hum along despite anecdotal evidence that, the tariffs, and the uncertainties are really hitting hard. Consumer confidence numbers are weak, Kathleen, at the same time, you have continued sticky inflation. The PCE price index rose a couple tenths yesterday. So year over year we’re really stuck. Inflation’s 2.7% and even higher on the core. And if you try to dig apart the data, you see that tariffs are having only a modest impact. But services prices are 3.3% and those are non-tradable goods. And that persistent, inflation there, suggests to me, that you have some still excess demand in the economy.
Consumer positives and negatives 00:03:27:06
Listen, for months people have said, oh, consumers are going to stop spending. And in fact, I do expect it to slow. But if you look in detail, disposable incomes are still rising in real terms. Household net worth continues to rise. That is increasing the propensity to spend out of disposable income. So I do expect consumer spending growth to slow. But it hasn’t yet. And, there are as many positive factors out there as there are negative factors.
So in terms of the positives, again, it seems like okay, you know, incomes are still growing. Wages are still growing as people that the the jobs numbers are weaker. But but what’s the negative. That means all not all of a sudden are people saying, oh, it’s going to be a terrible Christmas shopping season. And what would slow it down right now?
Okay, first the positives. Employment is still rising by a touch. Almost stall speed. Real wages are rising. So real inflation adjusted, disposable incomes rising. On top of that, you have this increase in ongoing increase in household net worth that is driving, consumption up. The negatives, you have slower growth in employment. You have tremendous uncertainties, around, President Trump’s tariffs and immigration policies; <these are> are distinct negatives that are leading people to be more cautious and save more, auto sales, you know, have been okay, but they dipped a little bit in the latest August data.
Looking ahead: positive holiday shopping? … 00:05:20:06
Looking forward to the holiday retail season. When we add things up, employment is higher than it was in late, 2020. For, I’d say the biggest negative is uncertainty, but things look like, the holiday retail season should be okay. Okay, okay, maybe a little on the positive side.
Key Driver: Excess demand drives inflation 00:06:29:11
Okay. So Kathleen, let’s think about the basics. Inflation is generated when you have excess demand. For that is total dollar spending growth exceeds, productive capacity growth, which we’re talking about, excess demand for all goods and services relative to, the production of those. And so, when you look at nominal GDP, the broadest measure of aggregate demand, it’s growing, you know, 4.5% year over year. So if you, if you’re, if you like, let’s let’s round it off. If you think of, productive capacity growing 2% and aggregate demand is growing at four and a half, then that explains the inflation where we are now. Now when we look at GDP, almost two thirds of it is consumption and two thirds of consumption is consumption of services.
Inflation arithmetic is still too high: services prices are key 00:07:33:13
Shelter, medical services are the are the two <service sector> biggies.. So when we look at the period before the pandemic, say from the mid to 2019, goods prices, were about flat, no inflation, no deflation. You had technological innovations that offset price increases. So it came out to no inflation. The inflation was, you know, about 2% per year inflation in services. Then you had, of course, the pandemic, The supply shock, but also the surge in demand in response to all the monetary and fiscal stimulus. And now you have a situation where, goods inflation is about 1%. So it’s not back to zero, it’s about 1%. And services inflation, as I noted, is over 3%.
Too much spending is generating inflation 00:08:39:16
And when you add that up, Kathleen, it suggests to me that the reason why we have this ongoing inflation is there is some excess demand in the economy. Let me toss out one caveat. Okay. A caveat on why that wouldn’t be the, prevailing factor. The shelter prices, rental car and the…owner occupied equivalent rent, that is still rising, pretty rapidly, but at a decelerating rate. And that rate of increase should continue to decelerate for a couple of years now because it tends to lag the Case-Shiller home price index, which has actually fallen for four consecutive months. And so the shelter component of inflation should be, reducing the inflation pressures. But nevertheless, when you add everything up, aggregate demand is still growing a little too fast to achieve that 2% inflation target.
Fed is focused on jobs market: Claims show firms not boosting layoffs 00:10:40:17
The Federal Reserve’s dual mandate is 2% inflation and maximum employment, GDP. Over on the sidelines, the Fed really focuses on its mandate, maximum employment. So what we’ve what we’ve been seeing in labor markets is with some bounces week to week. Initial unemployment claims are very low. And particularly if you think about the level of initial unemployment claims, that is job layoffs divided by the 160 million workforce. They’re very, very low. So what the claims suggest is businesses, even though there’s a lot of uncertainty out there that is leading them to, modify their production processes and, and their future plans, they’re not increasing layoffs.
Static job market conditions- 00:11:47:00
But at the same time, when you look at the, establishment survey of payroll gains, moderated dramatically. So at the same time, businesses aren’t laying off people. They’re not hiring many people at all. They’re in a kind of a stall mode, which I think is appropriate given the tremendous uncertainties, in the, in the policymaking environment and the constant, curveballs that that President Trump is throwing at the economy.
Solid growth despite challenges 00:12:25:19
That is, that is tying businesses in, in, in knots. So you have weakening labor markets at the same time, GDP is rising at, moderate rate. And in fact, one thing I should note is, when you look at the third quarter, which is now coming to an end, the Federal Reserve Bank of New York’s, now-cast estimates that it’s going to be 2.5% annualized growth. And the Federal Reserve Bank of Atlanta’s GDP-now, estimate is 3.4% annualized growth. Yeah. So it’s hard to say… It looks like the economy is doing okay despite the tremendous uncertainties. While the labor markets are clearly showing the negative impact of of the immigration shutdown and the uncertainties. Yeah. And that’s the part that’s the that’s the factor that has not been had to be dealt with forever.
Real Fed funds and R-Star benchmarks and more 00:14:12:16
Okay, so the Federal Reserve perceives and has for several years that its monetary policy is, is moderately restrictive because it looks at the federal funds rate, which is now 4 to 4 ¼ , subtracts off inflation and gets a real funds rate. That is, significantly higher than what the FOMC members estimate to be the long run real funds rate. Now, this concept of R-star keep in mind R-star is an estimate. The inflation adjusted funds rate that is consistent with 2% inflation and the economy growing along its potential path. R star is an unobservable variable. Yeah. And I think it’s I think it’s, it’s you shouldn’t hang your hat on R-star to base your monetary policy. So the key point here is the Fed still perceives monetary policy is mildly restrictive. But at the same time, various indicators, including the said the Federal Reserve Bank of Chicago’s, Financial Conditions Index suggest monetary policy is a little on the loose side.
Money supply has been on a tear after its Covid weakness 00:15:52:16
You have at the same time, aggregate demand in the economy is growing faster than that, which would be consistent with inflation being at at 2%. And then you look at other measures like money supply that have actually re accelerated. And let me make the following point. That’s difficult to assess already. Right. Since the onset of the pandemic, M2 money supply has increased over 40%. And all that liquidity is still sloshing around. Doubts out there in financial markets and ready to be spent and the fed the fed is kind of stuck in its way, thinking, oh, monetary policies, mildly restrictive. So the economy should be slowing down. But then despite being, you know, thrown so many curveballs by the Trump administration, and all the uncertainty, the economy’s continuing to grow at a pace that is faster than the Fed estimates potential growth. There’s, boom. And I and of course, we have seen in recent months, you know, a material decline in bond yields, which, which pushes up the valuations, of particularly the high-tech companies. When you look at the data, it’s hard to make a case that monetary policy is yeah, restrictive
The Miran factor 00:18:44:07
Miran perceives there’s a lot of room to lower rates here, ease monetary policy because, the Trump tax cuts and big shift toward deregulation will stimulate economic growth, push down deficits, and by pushing up economic growth, it’ll push down inflation. He has this kind of staunch supply side model where he thinks Trump’s economic policies will work to generate very strong growth, low inflation. So there’s a lot of room for the Fed to ease. There are big inconsistencies in his framework. One question is whether the extension of the 2017 tax cuts will have the same power, and in stimulating the economy as an outright tax cut of that same magnitude. There. Well, there are right now negatives to, the tariffs. And he sidesteps that… But secondly, and perhaps most importantly, he admits in his economic argument the huge negative impact of the clampdown on immigration to labor force growth, which is the biggest ingredient to economic growth. And so that’s an inconsistency in his broader macro view, the way he arrives at the need to lower rates is, he estimates, R-star, the natural rate of interest to be close to zero.
Apart from Miran- 00:21:06:02
The clampdown on immigration that will halt the growth in the labor force. And so we don’t want that. Well, I would I much rather have strong economic growth that invites immigrants that, boost the labor force that, is associated with a high real interest rate. That’s what he’s basically saying.
The Risk from the Miran view 00:21:38:20
Well, you’re going to have the opposite, but don’t worry, because the supply side impulses from the tax cuts and deregulation will overwhelm everything else. It’s just inconsistent. Now, Kathleen, the risk of lowering rates too much. Yeah. Well aggregate demand is already a little too fast to be consistent with 2% inflation is you could an inflationary expectations. That’s the risk.
Is the Fed targeting the right objective? 00:23:10:14
Kathleen, are you asking me to assess whether the fed should prioritize employment over inflation, inflation since 2021. And we’re going on five years in a row has been above the Fed’s target. Now, there’s no question but that we’ve seen a slowdown in employment. Where should the Fed’s priorities be now? Historically when economies have gone into recession, you had a sharp decline in employment and a sharp rise in the unemployment rate. But I don’t see that type of situation right now. You still see, adequate growth, even touching excess growth in aggregate demand. The biggest negative affecting labor markets is the President Trump’s policies on immigration and the uncertainties that he keeps throwing at the, economy almost entirely on immigration, on, visas, on tariffs. In response to these uncertainties, the businesses would slow their employment.
Few real excesses in the economy for tis transactors 00:24:34:03
If you look at if you step back and look at aggregate demand and you look at where businesses and households are, businesses are in a good position. They don’t have excess labor relative to productive to production. Businesses don’t have excess debt. Household balance sheets are in generally good shape. So unlike a traditional onset of recession, you don’t have imbalances that would suggest that businesses have to clean house and really lay off a ton of people. So I don’t think looking at historical patterns of the onset of recessions is appropriate to assess where we are right now, and then I would also come back and emphasize my point that the Fed has a dual mandate historically, it always has prioritized employment over inflation. But I’m asking, is that appropriate to do under the current circumstances when everything is okay except for poor economic non-monetary policies?
Fed remains labor-focused 00:27:20:19
<The Fed presumes…>Labor markets are going to weaken and that’s going to lower inflation to 2%. Based on its history, we shouldn’t be trusting the Fed’s forecasts and judgment. You know, what this adds up to is the Fed is basically bringing it and it’s, hoping inflation comes down, but it’s still prioritizing employment over inflation.
Fed lacks the tools to reverse the impediments it faces 00:27:54:05
And there are risks there. So what will the fed do. You know they’ll probably, you know, ease one more time this year. But if you look at the split among FOMC members, I think there are enough to tell the Fed, hey, we better slow down this easing because there could be risks to what we’re doing. And in fact, the risk could be that, hey, we’re wrong on the economy. You know, it keeps on showing resilience. And the key point here is the economy is being hurt by uncertainties and misguided non-monetary policies. Tariffs, immigration clampdown, and even if the Fed were to lower rates in an attempt to offset those negative factors, it can’t. Period. End of discussion. The distortions created by tariffs and the clampdown on immigration cannot be offset by monetary policy, which is an aggregate demand tool.
Dr. Mickey D. Levy
Mickey Levy is a macroeconomist who uniquely analyzes economic and financial market performance and how they are affected by monetary and fiscal policies. Dr. Levy started his career conducting research at the Congressional Budget Office and American Enterprise Institute, and for many years was Chief Economist at Bank of America, followed by Berenberg Capital Markets. He is a long-standing member of the Shadow Open Market Committee and is also a Visiting Scholar at the Hoover Institution at Stanford University.
Dr. Levy is a leading expert on the Federal Reserve’s monetary policy, with a deep understanding of fiscal policy and how they interact. He has researched and spoken extensively on financial market behavior, and has a strong track record in forecasting. Dr. Levy’s early research was on the Fed’s debt monetization and different aspects of the government’s public finances. He has written hundreds of articles and papers for leading economic journals on U.S. and global economic conditions, and has been an active voice on how financial markets are influenced by monetary policy. He has testified frequently before the U.S. Congress on monetary and fiscal policies, banking and credit conditions, regulations, and global trade, and is a frequent contributor to the Wall Street Journal, Bloomberg, and other media.
He is a member of the Council on Foreign Relations and the Economic Club of New York, and has previously served on the Panel of Economic Advisors to the Federal Reserve of New York, as well as the Advisory Panel of the Office of Financial Research.
Dr. Levy holds a Ph.D. in Economics from University of Maryland, a Master’s in Public Policy from U.C. Berkeley, and a B.A. in Economics from U.C. Santa Barbara.
