The Federal Reserve Chairman Jerome Powell is posed to the end of the sharpest tightening cycle since Chairman Paul Volcker whipped the Great Inflation in the early 1980s.

Investors naturally speculate how quicky the Fed will lower the federal funds rate. Will it rate cuts at each successive Fed policymaking committee meeting until it accomplishes its long-term target of 2.8%?

More fundamentally, though, can the Fed accomplish a soft landing. Can it lower interest rates quickly enough to avoid a recession without having inflation bounce back? Over the longer term, what is the sweet spot for interest rates—low enough to keep the economy expanding but not so low as to overheat labor markets and rekindle inflation?

The near prospects for continued economic expansion are good.

The pace of jobs creation has slowed and unemployment has risen to 4.2% but remains low by historical standards. We have not had an avalanche of layoffs that would ignite a self-feeding cycle of consumers cutting back and in turn, businesses cutting employment as opposed to merely slowing hiring.

Consumer spending powered 2.8% GDP growth in the 2nd quarter and as measured by the University of Michigan and Conference Board surveys consumer sentiment is strengthening.

Since Vice President Kamala Harris replaced President Joe Biden as the Democratic nominee, Americans have started feeling better about the direction of the country—and that’s reflected in her better standing in the polls than Mr. Biden’s when he bowed out—and should bear out in consumer spending.

Chairman Powell is reasonably confident inflation is headed for 2%, but it doesn’t have to hit that target on the nose.

What matters is that inflation, especially for durable goods, stays low enough that consumers do not rush to spend and bid up prices for automobiles and appliances today in anticipation that higher prices will outpace their incomes tomorrow. That would boost borrowing, create excess demand and accelerate inflation.

We may be closing in on that maximum, nonaccelerating rate of inflation (P*).

So far, retail sales and consumer spending have held up in the 3rd quarter and forecasters that I watch closely—Wells Fargo and the proprietary service Action Economics-- have the economic expansion continuing into next year.

As this column has noted, 2% is a rather arbitrary target without any strong basis in economic theory or empirical research. Just getting close to 2% without a recession would be victory enough to place Chairman Powell among the pantheon of central bankers.

The Fed will not likely be able to take interest rates down to the very low levels we enjoyed pre-COVID-19, because conditions in the economy beyond the influence of monetary policy may make the economy more disposed to inflation, and it’s not getting a lot of help from the White House.

Shelter—rents for apartments and homes and the rent homeowners could expect to obtain if they leased their dwellings—is 36 percent of the Consumer Price Index.

The barriers to building new apartments are worsening—notably permitting processes imposed by local government are getting longer and more cumbersome. New apartment construction is slowing, and investors are now betting on rents increasing.

New home construction has hardly been robust, and the rising apartment rents will push up the imputed rents on owner-occupied houses.

Most of the progress on inflation has been in the goods sector, where China is pushing its surplus manufacturing production on global markets, and deflation in the Middle Kingdom has factories slashing prices and selling at a loss. That can’t go on indefinitely.

In 2019 the federal deficit was 4.6% of GDP, and now it stands at 7.0%.

Neither former President Donald Trump nor Vice President Harris talk much about pulling that figure down. The former wants to cut taxes and the latter expand benefits for families—such as with subsidies for first home purchases and child tax credits.

Both talk about new revenue sources to finance their plans—Trump’s tariffs and Harris’s higher corporate tax rates are examples—but the history indicates that congress won’t fully fund such initiatives, or we wouldn’t be witnessing such as dramatic increase in federal borrowing from the pre to post COVID-19 economies.

With increasing fiscal stimulus, the Fed would have to more restrictive than implied by its current long-run target for the Federal Funds rates to keep inflation from reaccelerating.

This shouldn’t be a problem for equity investors. The four decades prior to the Global Financial Crisis inflation and interest rates were higher than decade before COVID-19 and stocks did fine.

With the economy continuing to expand, the outlook for U.S. profits is strong—stronger than abroad—ordinary investors are bullish about stocks for their retirement accounts and savings generally and U.S. equities should resume their upward trend.
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.