The economic news lately has been good for the U.S. — job growth remains reasonably robust, with unemployment below 4%, and inflation has come down. U.S. Federal Reserve Chair Jerome Powell appears to be focused on when the Fed can safely cut interest rates — but he should leave things alone unless and until a recession looms.

Federal assistance during the COVID-19 shutdown was more generous than needed, and with people unable to get out to restaurants and other service establishments, Americans’ savings jumped.

As the economy reopened, consumers spent their paychecks as well as that savings. Aggregate demand exceeded supply and inflation surged. In 2023, consumer spending accounted for 60% of the 2.5% growth in GDP.

The U.S. labor market, meanwhile, remains relatively tight — job openings exceed job seekers 1.4 to 1, whereas a ratio below 1.0 is likely needed to neutralize inflation. This is especially the case in the service sector, where wage pressures are felt the most.

The Fed prefers to focus on the personal consumption expenditures index from the gross domestic product accounts, rather than the consumer-price index. The PCE is mostly compiled from the same Bureau of Labor Statistics surveys but includes items households don’t pay for directly — for example, medical expenditures paid through employer contributions to health insurance and Medicare.

During 2023, the PCE deflator rose only 3.7%, and for goods it was 1.2% and services it was 5.1%. However, in January, the monthly change on an annualized basis was 4.2%, owing mostly to continued stubborn inflation in the services sector at 7.4%.

Those data indicate that the Federal Reserve should stay the course and avoid prematurely celebrating the end of inflation above 2%. The history of 100 episodes across 40 countries, as compiled by the International Monetary Fund, indicates that when central banks refrain from cutting interest rates too quickly, longer-term growth performance is better.

While considerable attention is focused on the federal-funds rate, our real focus should be on the 10-year Treasury rate, which provides the benchmark for mortgage rates and other long-term borrowing.

For example, high-grade corporate bonds normally trade 70 to 140 basis points above the Treasury benchmark. Over the past six months, those bonds have slipped to the lower end of the range on speculation that the Fed will reduce rates as inflation subsides.

That 10-year Treasury yield BX:TMUBMUSD10Y, meanwhile, was low by historic standards during the period after the global financial crisis of 2007-09. From 2009 to 2023 it averaged 2.4% and, adjusting for inflation, the real interest rate was 0.2%.

Going forward, federal deficits, investments to mitigate for climate change and build out green-energy alternatives to fossil fuels, along with the investments needed to develop and apply artificial intelligence, will boost demand for long-term capital.

A good benchmark for the long-term rate of interest in a healthy economy is the sustainable rate of inflation plus the trend rate of growth, which the Fed and macroeconomists generally peg at 1.8%, plus inflation. The productivity boost from AI should permit a bit more real growth.

If inflation is sustainable at 2%, as the Fed targets, then a 10-year Treasury rate of 4% is just about right. If attainable inflation runs a bit higher — for example, 3% — then a benchmark Treasury rate of 5% is about right.

Fed policy prominently affects the economy through the housing market.

With the 10-year Treasury rate near 4%, mortgage rates have fallen and home prices are rising again; residential construction was up 5.4% in January from a year earlier. The housing market does not need additional support.

Investments in artificial intelligence and elsewhere in the economy are reasonably robust. As noted, the labor market hardly needs further encouragement.

The Fed has two key levers: the federal-funds rate and adding and subtracting from its balance sheet by purchasing and selling U.S. Treasury and mortgage-backed securities. Since March, it has been reducing its balance sheet, and that has helped support a higher Treasury rate.

Over the 40 years prior to the financial crisis, nominal and real 10-year Treasury rates averaged 7.4% and 3.4%, respectively. The U.S. economy did reasonably well and the S&P 500 SPX returned 10.5% per year against average inflation of 4%.

Seen in that light, leaving the 10-year Treasury rate around 4% seems hardly restrictive at all. My advice to Powell: Take the Federal Open Market Committee fishing and leave things alone.
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.