Stephen Miran on interest rates Are big cuts needed?
ROBERT ARMSTRONG
Good morning. US new home sales rose 20 per cent between July and August. This came as a surprise to the market and to Unhedged — our view of the new home market is pretty bleak, as regular readers will know. It could be a blip. Some observers put it down to homebuilders cutting prices and offering incentives. But it was interesting that homebuilder stocks rallied only modestly on the news. Send us your thoughts: unhedged@ft.com.
Stephen Miran on r*
Stephen Miran, until recently an economic adviser to the president and now a Federal Reserve governor, thinks the federal funds rate should be much lower than it is, and much lower than all the other members of the central bank’s rate-setting committee think it should be. The cavernous difference in views was reflected in last week’s objectively funny “dot plot” of committee members’ views of the appropriate policy rate at the end of 2025:
Having an out-of-consensus view on the committee is a good thing: intellectual diversity sharpens minds and improves decision-making. But it places a burden on the outlier to explain themselves. Miran did this in a speech on Monday.
The speech starts with a clever framing of the discussion:
Changes in inflation and employment?.?.?.?receive due attention from Fed officials. However, changes in the neutral rate, or the policy rate that would be neither expansionary nor contractionary when the economy is at full employment, are often under-appreciated?.?.?.?
Because many r* (neutral rate) estimates are based on empirical models requiring a great deal of time-series data, they can be backward-looking and slow to adjust. Moving too slowly to update a rapidly changing neutral rate raises the risk of policy mistakes.
As a rule, when one talks about where the fed funds rate should be, one starts by talking about what is happening with inflation and employment. Miran declines to do so with good reason. Core inflation is running about a percentage point above the Fed’s 2 per cent target, and the unemployment rate is 4.3 per cent, more than a percentage point below the 30-year average. That’s an awkward starting point for someone arguing that the fed funds rate is vastly too high.
So Miran focuses instead on the neutral rate of interest, or “r*” — the rate of interest that balances the desire to borrow (and invest the borrowings) and the desire to lend (and collect interest) such that the economy is neither under- nor overstimulated by too little lending or too much.
But Miran won’t be talking about economists’ estimates of r*, either. Awkwardly, again, those models say the neutral rate is much higher than Miran thinks it is. The two models the New York Fed publishes, for example, put real r* at 1.37 and 0.84 per cent; assuming two points of inflation gives you an estimate of roughly 3 per cent — which makes the current fed funds rate “modestly restrictive”, just as Fed chair Jay Powell likes to say. Miran thinks real r* is about zero.
But those models are “backward-looking”, Miran says, and he wants to talk about what r* is now and will be in the future (just how far into the future turns out to be a key element of how to read the speech; more on that shortly). And his argument is that President Donald Trump’s immigration, tariff and tax policies will bring the neutral rate down a lot.
On immigration he starts with a straightforward point. If you throw a few million people out of the country and bar the door, demand for housing will go down and rents will soften:
Forecasters have under-appreciated the significant impact of immigration policy on rent inflation?.?.?.?Albert Saiz finds an elasticity of rents with respect to immigrant occupants of about 1. Net immigration averaged roughly 1mn per year in the decade leading up to the pandemic. Given that roughly 100mn Americans rent, net zero immigration going forward would imply 1 point lower rent inflation per year
I’m no economist, but I agree that supply and demand matter to prices. Fewer people + same number of housing units = cheaper rent, all else equal.
So Miran has a point. But it’s not just rent:
It is plausible to me that 2mn illegal immigrants will have exited the country by year end, thereby reducing annual population growth from 1 per cent to 0.4 per cent. Based on estimates from both [Sebastian] Weiske and [Paul] Ho, a 1 percentage point drop in annual population growth can reduce r* by 0.6 percentage point. So, the expected decline in US population growth equates to a nearly 0.4 percentage point drop in the neutral fed funds rate.
Here Miran loses me. Keeping it simple, if the population gets smaller, I would expect both supply and demand to fall, and the net effect on inflation should be zero. To be more precise than that, you would have to have a messy argument about the differing supply and demand contributions of immigrants versus the native-born. But instead of a messy answer, we get a very precise predicted decline in the neutral rate. Maybe I am missing something, but that strikes me as bonkers. Also, might not a country with near zero population growth have low demand for savings because its economy is a bit stagnant? Is that the kind of lower r* that Miran is keen on?
On to tariffs:
The Congressional Budget Office estimates tariff revenue could reduce the federal budget deficit by over $380bn per year over the coming decade. This is a significant swing in the supply-demand balance for loanable funds, as national borrowing declines by a comparable amount?.?.?. This 1.3 per cent of GDP change in national saving reduces the neutral rate by half a percentage point.
To simplify (if I understand correctly): the government is borrowing a lot to fund itself; the collection of tariff revenue means it will borrow less, and so total demand for borrowing will fall; but supply of lendable funds stays the same; so the price of borrowing, aka r*, will fall.
Once again, I’m not going to sit here and argue that supply and demand do not determine prices. The idea that you can talk about this stuff in isolation and come up with an estimate down to the decimal point seems pretty odd, though. And what Miran says about Trump’s tax-cutting budget complicates the issue further:
The large tax law passed this year also has a strong effect on national saving?.?.?.?The [Council of Economic Advisers] calculates an increase in national saving of $3.83tn over the next 10 years (relative to the previous policy baseline), resulting from economic growth induced by tax policy. This represents roughly 1.3 per cent of GDP, implying a half of a percentage point reduction in r* and the appropriate policy rate
Miran has argued that higher revenue from tariffs — import taxes — reduces government borrowing and therefore r*. But here (unless I am misreading) he argues that lower revenue from taxes stimulates the economy, increasing the supply of available capital and lowering r*. Which is it? Clever readers will know how Miran squares this circle. The difference is that Americans don’t pay the tariffs, as they do other taxes:
With respect to tariffs, relatively small changes in some goods prices have led to what I view as unreasonable levels of concern. While my read of the elasticities and incidence theory is that exporting nations will have to lower their selling prices
I don’t know who will end up paying the tariffs when the global trade system reaches a new equilibrium following the Trump shock. It seems reasonably clear, however, that exporting nations are not paying the tariffs right now; US importers and US consumers are mostly splitting them (hence Miran’s use of the future tense in the quote above). Maybe Miran will be right in the end, though.
Miran has another point to make on trade policy. He thinks a huge inflow of foreign capital is set to pour into the US as a result of Trump’s trade negotiations:
Loans and loan guarantees pledged by east Asian countries in exchange for relatively low tariff ceilings have reached $900 billion. These guarantees entail an exogenous increase in credit supply, which research suggests would be around 7 per cent. Using [CEA’s] estimates of the interest elasticity of investment and Michael Boskin’s interest elasticity of saving, this would further reduce neutral policy rates by around two-tenths of a percentage point.
Again: supply of funds goes up, demand for funds stabilise, r* goes down. My question is whether these funds will actually show up (“pledged” is not delivered), and if so, when. Miran thinks the fed funds rate needs to drop very far right now. But a lot of the things he talks about (barring the decline in immigration) will take a long time. So even where I am sympathetic to his arguments, they don’t get me to a sub-3 per cent fed funds rate by the end of the year. |
