MNI INTERVIEW: Fed Cuts To Continue But Neutral Not Far-Tracy

MNI (WASHINGTON) - The Federal Reserve is likely to look past economic policy changes from the incoming administration of President-Elect Donald Trump next year and keep cutting interest rates toward a neutral level that has probably risen, former senior Fed economist Joseph Tracy told MNI. 

While an expansionary fiscal stance might generally call for less monetary easing, it won't be easy to calibrate the likely effect of significant tariffs and changes to immigration policy that could take priority for the administration and Congress, said Tracy, former senior adviser to Dallas Fed President Robert Kaplan and ex-senior economist at the New York Fed.

"I would be shocked if they don't try to work with Congress on the border, but not in a way the flamboyant rhetoric sounded. It's easier to stop inflows than try to get people who are here out. And how can we get the inflows we'd like to have?" said Tracy, now a non-resident senior fellow at the conservative American Enterprise Institute and a distinguished fellow at Purdue University’s Mitchell E. Daniels, Jr. School of Business, in an interview.  

"On tariffs, at least we have a little more evidence from past so that helps people make an informed judgement on the implications. But again, it’ll depend on the voices Trump brings into his administration and how much resistance they'll offer on certain points. And maybe they'll say we want to work on the border instead." 

CLOSE TO NEUTRAL RANGE

The FOMC will be inclined to ignore the campaign rhetoric and policy uncertainty until actual policies take shape, Tracy said. Instead they'll spend 2025 trying to learn about the neutral rate through community and firm contacts. 

"It doesn’t look like what it was in the past. There's a general view in markets that it’s higher, the question is how much?" he said, adding he reckons the neutral rate hasn't jumped as much as some think. "Absent any big shock, the committee can observe and get a sense of whether we're getting close." 

The middle 50% of the latest set of FOMC projections estimated the real neutral rate at 0.75% to 1.4%, and it would be sensible to start with an assumption that it's the high end of that range, he said. With underlying inflation now around 2.7%, the nominal fed funds rate should be just above 4%, Tracy said. The FOMC is expected to cut another quarter-point next month, taking the benchmark rate to a 4.25%-4.5% range. 

"That's pretty close. We don’t know how quickly from this point on inflation will move down, but it’s probably going to be slow. The committee can follow inflation down to target next year and take its time to learn about neutral." (See: MNI INTERVIEW: Fed Could Pause As Prices Spike in 2025-Gagnon)

POLICIES TO TAKE SHAPE

Immigration was a top issue for U.S. voters in last week's presidential election, and Trump has promised to restrict both legal and illegal flows upon his return to the White House. 

Economists have warned his plan to expel millions of immigrants could push prices higher and lower overall growth, but Tracy said that's unlikely to happen at the scale discussed in the campaign. The priorities instead are likely to be reforms more acceptable to all voters, such as more restrictive asylum rules and legal work programs that favor skilled workers. 

"Let's reexamine the definition of asylum and tighten that up. Let's provide more resources for the asylum claims. It's better to have Congress weigh in and get a bipartisan solution, maybe even a compromise on work permits for educated and skilled workers. But where it becomes very difficult is to get rid of the people who are here," he said. 

Trump could be more keen to work with a Republican-led Congress rather than through reversible executive actions in this second term, and that could also rein in some of his campaign's costliest proposals on tax cuts, Tracy said. 

"If Congress is more fiscally responsible, that should discipline some things thrown out on the campaign trail. We'll have to see and not get all anxious ahead of time."