Original letter from Warren to Powell: What does the Federal Reserve's monetary policy bring?

Author: Elizabeth Warren; Translator: Deng Tong, Golden Finance

After the European Central Bank and the Bank of Canada have taken the lead in cutting interest rates, the Federal Reserve does not seem to have any plans to cut interest rates. U.S. Senator Elizabeth Warren wrote to Jerome Powell, Chairman of the Federal Reserve System, to explain her position on the current monetary policy in the United States, and pointed out that the Federal Reserve's monetary policy does not help reduce inflation - it is pushing up the cost of housing and auto insurance. And the current monetary policy may lead to a recession and make thousands of American workers unemployed. Golden Finance translated the original letter as follows for readers.

Dear Chairman Powell:

We write today to urge the Federal Reserve (Fed) to lower the federal funds rate from its current 20-year high of 5.5%. Sustained high interest rates have led to slower economic growth and failed to address the remaining key drivers of inflation.

In addition, the European Central Bank (ECB), which, like the Federal Reserve, is also tasked with guiding inflation to its 2% target, cut interest rates for the first time in five years. Now is the time for the Fed to do the same. Major central banks have cut rates or are leaning toward them. The European Central Bank cut its rate on Thursday from 4% to 3.75%.

On Wednesday, the Bank of Canada cut rates, becoming the first of the Group of Seven (G7) major economies to do so. Sweden, Switzerland, Hungary and the Czech Republic have already cut rates. The Fed's decision to keep rates high continues to widen the gap between European and U.S. interest rates, as lower rates could push up the dollar and tighten financial conditions.

The Fed's current rate policy is also having the opposite effect of its intended effect: It's pushing up the cost of housing and auto insurance, which are now the main drivers of overall inflation. In fact, "excluding housing, overall personal consumption expenditures (the Fed's preferred inflation measure) increased 1.8% in April, below the Fed's target... More importantly, personal consumption expenditures excluding housing have remained at or below 2% since October."

This housing-related inflation is directly driven by high interest rates:Lower interest rates will reduce the cost of renting, buying, and building a home, reducing the single largest monthly expense for Americans. Lower interest rates may also reduce the cost of auto insurance, which has risen entirely due to factors unrelated to loan costs.

In addition to having the opposite effect than intended, the Fed's decision to keep interest rates high continues to threaten the economy. Many economists agree that "inflation has fallen enough for the Fed to start cutting rates before it causes more serious economic damage." Mark Zandi, chief economist at Moody's Analytics, emphasized that "these (high) interest rates are like a corrosive agent for the economy; you know, they will drag down the economy, and at some point, the economy may collapse." In addition, Zandi urged everyone not to "sacrifice the economy for the 2% target," noting that although layoffs are currently small, "this is the next step for companies." JPMorgan analysts believe that the Fed's current interest rates may even fuel inflation, and prices will only stabilize if the central bank starts to cut interest rates.

Participants in the May FOMC meeting also noted that "high interest rates could lead to financial system fragility."

Housing inflation makes up a large portion of the Consumer Price Index (CPI), and high interest rates are causing housing costs to rise rather than fall. High interest rates push up rents, mortgages, and construction costs, limiting the supply of housing and keeping prices high. Zandi stressed that if "single-family rents are removed from the Fed's preferred price measure, inflation is already below 2%."

The core problem is that "the Fed's interest rate tools are poorly matched to housing inflation and, if anything, have exacerbated it." The inventory of single-family homes has fallen 75% from a peak of 4 million to about 1 million today. Higher rates are particularly bad for young people (18-35) trying to become homeowners, as homeownership rates for this age group are down nearly 10% from previous generations of young people. Lower mortgage rates will encourage more people to sell their homes, which in turn will increase housing supply, lower prices, ease the cost of renting, and ultimately increase homeownership.

Higher rates have also further increased construction costs, causing developers to cancel, significantly delay or shelve a growing number of projects across the country, “exacerbating the housing shortage by raising the cost of credit for builders and developers.” The U.S. already faces a severe housing shortage, and the Fed’s refusal to cut interest rates has exacerbated that shortage and pushed up inflation.

Fed rate hikes also don’t seem like the wrong tool to reduce other drivers of inflation, such as auto insurance.If auto insurance is excluded, overall inflation would be “only half a percentage point lower” than the Fed’s desired 2% rate. But the increase in motor vehicle insurance costs reflects a variety of factors, including a shortage of mechanics, more severe and more frequent crashes, climate change that has led to more vehicles damaged by extreme weather, and more complex, more expensive cars to repair. High interest rates can’t mitigate all of these factors. In fact, the Fed’s rapid rate hikes in 2022 may have had the opposite effect than it intended, prompting insurers to raise premiums. According to one analysis:

This could also be another area where the Fed’s rate hikes could exacerbate problems. Insurance companies invest premiums as “float” before they need to pay claims. When rates began to rise, insurers got stuck investing in long-term securities and ended up losing money. In other words, industry losses have nothing to do with rising car repair costs in a sense, but with their own poor investment strategy.

The Fed’s monetary policy is not helping to reduce inflation. In fact, it is driving up the cost of home and auto insurance—two of the main drivers of inflation—threatening the health of the economy and threatening a recession that would force tens of thousands of American workers out of their jobs. You’ve kept rates too high for too long: It’s time to cut them.

Thank you for your attention to this matter.

Elizabeth Warren