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Glenn’s Policy Advice to President Trump

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Note: In this opinion column, Glenn discusses issues—including the U.S. current account deficit, the role of the U.S. dollar in the international financial system, and the effect of the exchange value of the dollar on the U.S. economy—covered in Macroeconomics, Chapter 18 (Economics, Chapter 28).

This opinion column first appeared in Project Syndicate.

The Policy Pivot Trump Needs

US President Donald Trump’s administration believes that the dollar’s reserve-currency status has tilted the global playing field against America and undermined the country’s competitiveness. While wrong about the dollar, the White House is right about an issue that economists—who, unlike voters, abstract from the exchange rate’s distributional effects—often ignore. As November’s midterm elections approach, the administration needs a policy pivot if it is to meet its rebalancing goals and strengthen the US economy.

To be sure, the dollar’s global role, all else being equal, increases its value but also leaves the United States running larger current-account deficits than it would otherwise. But focusing solely on a reserve currency’s challenges overlooks its benefits and, importantly, the non-tariff policy tools that can address domestic spillovers—the impetus for Trump’s “Liberation Day” tariffs, which aimed to rein in imports and promote exports.

Economists have responded to the Trump administration’s concerns about US Federal Reserve swap lines with foreign central banks by arguing that they are a feature, not a bug, of the dollar’s position, which requires the US to supply greenbacks when needed. They have also pointed out that while current-account deficits may be associated with a strong dollar, the US has had large trade imbalances, with the attendant fretting, even when the greenback’s foreign-exchange value has been relatively low.

Instead, economists emphasize the dollar’s “exorbitant privilege,” including lower borrowing costs and the ability to impose financial sanctions on geopolitical adversaries. Moreover, they counter that tariffs are not an effective response to the dollar’s impact on US exports because they raise domestic manufacturing costs (roughly half of US imports are intermediate goods) and do not reduce the macro imbalances driving the overall trade deficit.

These arguments are correct, but also incomplete. In fact, Trump’s concerns reflect a crucial political-economy question: the distributional implications of dollar dominance.

To see why, consider Robert E. Rubin’s tenure as US Treasury Secretary in the Clinton administration. His mantra was that “a strong dollar is good for America.” He could have been referring to the features of the US economy that underpin the dollar’s status, such as institutional and policy stability and deep financial markets. Whatever the exact meaning, his stance reflected the prevailing view on Wall Street, which benefited from the stronger dollar implied by reserve-currency status.

But for all the benefits that accrue to financiers and consumers, a stronger dollar makes it harder for US industry to compete globally, to the detriment of industrial employment, incomes, and communities. Trump’s position is thus reminiscent of the political tug-of-war in 1925 in the UK over returning pound sterling to its pre-World War I exchange rate under the gold standard. Despite supporting financial interests and the stronger pound, then-Chancellor of the Exchequer Winston Churchill said: “I would rather see finance less proud and industry more content.”

Trump’s economic agenda recognizes the adverse effects of globalization and technological advances on certain parts of American society, in contrast to economists’ emphasis on averages and overall benefits. But Trump misses the simple insight that there are more—and better—ways to help US manufacturing and its left-behind workers than through a weaker dollar alone. He has several policy instruments at his disposal that can address these voters’ concerns and help achieve his administration’s goals while preserving support for the dollar’s reserve-currency role.

For starters, the administration can support a robust industrial sector by increasing public funding for basic research, which advances technology, and a network of applied research centers to diffuse advances in industrial processes. Streamlining regulatory approvals for construction and electricity transmission will also be crucial.

Second, to help workers develop new skills, the administration could channel more resources toward community colleges, while a substantially expanded Earned Income Tax Credit would increase rewards for work. Lastly, more targeted place-based aid could help those areas facing severe disruptions from globalization and technology.

By focusing on the problems associated with a stronger dollar, Trump and his economic advisers have asked an old question in a new way. Their mistake is insisting on answering it with the wrong instrument. Weakening the dollar, including by eroding policy predictability and the economic institutions underpinning its hegemony, will exacerbate the affordability pressures many Americans face and harm the country’s fiscal position. The question now is whether the administration will see the need for a policy pivot in time to affect the midterms.

New BEA Releases Show Slower Growth and High Inflation

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The Bureau of Economic Analysis (BEA) released two reports this morning (May 28): “GDP (Second Estimate) and Corporate Profits, 1st Quarter 2026” and “Personal Income and Outlays, April 2026.” The BEA revised downward its estimate of real GDP growth in the first quarter of 2026 from an annual rate of 2.0 percent to an annual rate of 1.6 percent. Economists surveyed by the Wall Street Journal had expected that the BEA would leave its estimate of real GDP growth in the first quarter unchanged. The following figure shows the BEA’s estimated rates of GDP growth in each quarter beginning with the first quarter of 2022.

The following figure—taken from the BEA report—shows the contributions of each component of spending to the BEA’s downward revision of its estimate of GDP growth. The growth of both consumption spending and investment spending, which are the largest component of GDP, were revised downward. The downward revision in consumption spending reflects lower spending on services and the downward revision in investment spending reflects lower business spending on inventories.

As we’ve discussed in previous blog posts, to better gauge the state of the economy, policymakers—including former Fed Chair Jerome Powell—often prefer to strip out the effects of imports, inventory investment, and government expenditures—which can be volatile—by looking at real final sales to private domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers increased at an annual rate of 2.4 percent in the first quarter, which was well above the 1.6 percent rate of increase in real GDP and also above the U.S. economy’s expected long-run annual real growth rate of 1.8 percent. Note also that real final sales to private domestic purchasers grew by 2.9 percent in the third quarter of 2025, during which real GDP grew by 4.4 percent, and by 1.9 percent in the first quarter of 2025, when real GDP declined by 0.6 percent. So this measure of output is more stable and likely is a better indicator of the underlying growth rate in the economy than is the growth rate of real GDP.

The BEA’s “Personal Income and Outlays” report this morning included monthly data on the personal consumption expenditures (PCE) price index. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2019, with inflation measured as the percentage change in the PCE from the same month in the previous year. In April, headline PCE inflation was 3.8 percent, up from 3.5 percent in March. Core PCE inflation in April was 3.3 percent, up slightly from 3.2 percent in March. Headline PCE inflation was slightly below and core PCE inflation was equal to the forecasts of economists surveyed by FactSet. Both headline PCE inflation and core PCE inflation remain well above the Fed’s 2 percent annual inflation target.

The following figure shows monthly PCE inflation and monthly core PCE inflation calculated by compounding the current month’s rate over an entire year. (Often referred to as 1-month inflation.) Measured this way, headline PCE inflation fell from the very high rate of 8.9 percent in March to a still high rate of 4.9 percent in April. Core PCE inflation declined from 3.6 in March to 2.9 percent in April. Even leaving aside the effect of rising gasoline prices on headline PCE, these data show that in March both core and headline PCE inflation were well above the Fed’s target.

Former Fed Chair Jerome Powell frequently mentioned that inflation in non-market services can skew PCE inflation. Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices rise, the prices of financial services included in the PCE price index also rise. Powell has argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 3.7 percent in April, up from 3.4 percent in March. Core market-based PCE inflation was 3.1 percent in April, unchanged from March. So, both market-based measures, although lower than the full PCE measures, show inflation in April remaining well above the Fed’s 2 percent target.

New Fed Chair Kevin Warsh argued in testimony before the Senate that the Fed should stop relying on headline PCE inflation: “The measures [of inflation] I prefer are looking at things that are called trimmed averages. We take out all of the tail-risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy.”

Trimmed-mean PCE inflation drops the 8 percent of goods and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates. A closely related measure, median PCE inflation, is calculated by listing the inflation rate in each individual good or service included in the PCE and identifying the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates.

The following figure shows headline PCE inflation the (blue line), core PCE inflation (the brown line) and trimmed-mean PCE inflation (the red line). Trimmed-mean PCE inflation in April was 2.4 percent, well below both headline and core PCE inflation.

The following figure from the web site of the Federal Reserve Bank of Cleveland shows headline PCE inflation (the green line), core PCE inflation (the blue line), and median PCE inflation (the brown line). In April, median PCE inflation was 2.8 percent, also below both headline and core inflation. So Warsh has a point that these two measures of inflation, which are less affected by particularly high or low rates of inflation in some goods and services, indicate that inflation has been running below the Fed’s currently preferred measure. But these measures also show inflation running well above the Fed’s 2 percent annual inflation target.

Today’s macro data have had little effect on investors who buy and sell federal funds futures contracts. For some time, investors have seen little likelihood that the Fed’s policymaking Federal Open Market Committee would cut its target for the federal funds rate until sometime next year. These investors see it as far more likely that the committee will raise its target by the end of the year than that it will cut it.

Why Doesn’t Apple Manufacture the MacBook Neo in the United States?

Image of the MacBook Neo from apple.com

The United States hasn’t exported more goods and services than its imported since 1975. The following figure shows the U.S. trade deficits since 1949 as a percentage of GDP. (In this figure, we’re measuring the trade balance as net exports rather than the trade balance as reported in the balance of payment accounts. The two measures are highly correlated.)

As we discuss in Macroeconomics, Chapter 18 (Economics, Chapter 28), a trade deficit is driven by the relationship between a country’s national saving and domestic investment rather than by the competitiveness of a country’s exports or by the trade agreements a country has with its trading partners.

Clearly, though, many politicians see a trade deficit as a problem. Some politicians have argued that the U.S. trade deficit would shrink if more of the manufactured goods Americans consume were produced in the United States. Would it be possible, for example, to produce more consumer electronics in the United States? A few months ago, Apple stopped assembling units of the Mac Pro, its high-end, professional workstation computer, at a facility in Austin, Texas. More recently, Apple announced that it would begin assembling its Mac Mini, a compact desktop computer that lacks a keyboard and a monitor, in a new factory in Houston. These examples indicate that Apple can produce electronic products in the United States. But the number of Mac Pros or Mac Minis Apple sells each year is very small compared with the estimated 248 million iPhones it sold in 2025.

In March, Apple introduced the MacBook Neo. At a price of $599 ($499 if you are a college student or faculty member), the Neo is Apple’s first entry into the low-priced laptop market that had been dominated by the Google Chromebook. By the end of April, sales were running far above Apple’s initial forecasts and the firm was planning to double production of the Neo from 5 million units to 10 million—all of which would be assembled in China or Vietnam.

Why doesn’t Apple assemble the Neo in the United States? There are several reasons, but the most important is that the Neo is Apple’s first entry into the low-priced laptop market that is now dominated by Google’s Chromebook—all of which are assembled overseas. Apple is able to price the Neo at $599 only if it keeps its production costs very low. Workers who assemble electronic products like laptops require substantial training. Firms such as Foxconn and Quanta Computer have been assembling electronic products for many years in countries such as China and Vietnam. As a result, these countries have large numbers of workers experienced in assembling electronic products. U.S.-based firms have many fewer workers with this experience.

Assembly lines for electronic products need to be flexible to respond quickly when firms introduce new models like the Neo. So, in addition to hiring hundreds of thousands of workers to work on assembly lines, Foxconn, Quanta, and other firms operating in China, India, and Vietnam hire thousands of engineers. Typically, these engineers do not have college degrees, but they have sufficient training to rapidly redesign and reconfigure assembly lines to produce new models. In 2010, when President Barack Obama pressed Steve Jobs, the late Apple CEO, to produce iPhones in the United States, Jobs stated that he would need 30,000 such engineers if Apple were to make iPhones in the United States, but “you can’t find that many in America to hire.”

In addition, wages are much higher in the United States than in China or Vietnam. Workers assembling electronic products in China earn about $6 per hour. Workers doing the same jobs in Vietnam earn only about $2 per hour. In the United States, according to the Bureau of Labor Statistics, in April 2026, production workers in computer and electronic product manufacturing were earning $39.32 per hour.

The factories that assemble Apple products in Asia typically have many suppliers located near them—a so-called supplier ecosystem. Some suppliers make components of the products—although other components are produced outside of Asia, including in the United States—as well as providing repair, maintenance, and other services to the factories. The lack of such a supplier ecosystem would make assembling Neos in the United States very difficult. According to an article in the New York Times, when Apple started producing the Mac Pro in Austin, Texas, it had trouble finding a local firm to produce the custom screws needed in assembling the computers. According to the article, “In China, Apple relied on factories that can produce vast quantities of custom screws on short notice. In Texas, … [Apple had to rely on a] 20-employee machine shop that … could produce at most 1,000 screws a day.”

Production of some electronic goods—notably computer chips—has been expanding in the United States. In 2022, Congress passed the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act. The Act authorized the federal government to pay subsidies to help firms increase chip production in the United States. Intel, TSMC, Samsung, and Micron have all constructed new chip factories in the United States. As we mentioned earlier, Apple intends to assemble its Mac Mini in a new factory in Houston.

But the United States lacks a comparative advantage in the assembly of high-volume electronic products like the iPhone or MacBook Neo. So it’s unlikely that the expansion of U.S. chip production will be followed by a similar expansion in the assembly of smartphones and computers.

CPI Inflation Worsens, As Expected

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Today (May 12), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for April. As expected, higher energy prices resulting from the conflict in Iran led to a jump in inflation. The following figure compares headline CPI inflation (the blue line) and core CPI inflation (the red line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous year, was 3.8 percent in April, up from 3.3 in March. This was the highest inflation rate since May 2023.
The core inflation rate, which excludes the prices of food and energy, was 2.7 percent in April, up slightly from 2.6 percent in March.

Headline inflation and core inflation were both slightly higher than economists surveyed by the Wall Street Journal had expected.

In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) was a very high 8.0 percent in April, which was actually down from 10.9 percent in March. Core inflation (the red line) was 4.6 percent in April, up from 2.4 percent in March.

The following figure emphasizes the role played by energy prices in causing the jump in inflation. The blue line shows the 1-month inflation rate in all energy prices included in the CPI. Inflation in energy prices declined from a very high 245.1 percent in March to a still high 56.6 percent in April. The red line shows the 1-month inflation rate in gasoline prices, which declined from an astounding 907.4 percent in March to a still very painful 88.8 percent in April.

Did the jump in energy prices pass through to increases in food prices, which are a key concern for many consumers? The following figure shows 1-month inflation in the CPI category “food at home” (the blue bar)—primarily food purchased at grocery stores—and the category “food away from home” (the red bar)—primarily food purchased at restaurants. Inflation in grocery prices rose 8.5 percent in April after declining in March. Inflation in food prices away from home was 2.8 percent in April, down from 2.9 percent in March. The high rate of increase in grocery prices was due to rising energy prices, as well as to sharp increases in beef and fruit and vegetable prices, which rose for reasons largely unrelated to higher energy costs.

What effect is this inflation report likely to have on the Fed’s policymaking Federal Open Market Committee (FOMC) at its next meeting on June 16–17—Kevin Warsh’s first meeting as Fed chair? Earlier this year, some market analysts believed that replacing Jerome Powell as chair with Warsh would increase the probability of the FOMC cutting its target for the federal funds rate this year. But the acceleration in inflation during the past two months, even if it proves to be temporary, and relatively strong data on economic growth and employment make it unlikely that Warsh will push for a rate cut any time soon. At this point, trading by investors in the federal funds futures market favors the FOMC neither raising nor lowering its federal funds rate target during the remainder of this year.

Surprisingly Strong Jobs Report

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This morning (May 8), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for April. The report showed a stronger than expected increase in employment.

The jobs report has two estimates of the change in employment during the month: one estimate from the establishment survey, often referred to as the payroll survey, and one from the household survey. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and Federal Reserve policymakers believe that employment data from the establishment survey provide a more accurate indicator of the state of the labor market than do the household survey’s employment and unemployment data. (The groups included in the employment estimates from the two surveys are somewhat different, as we discuss in this post.)

According to the establishment survey, there was a net increase of 115,000 nonfarm jobs during April. Economists surveyed by the Wall Street Journal had forecast an increase of only 55,000 jobs. Economists surveyed by Bloomberg had a slightly higher forecast of a net increase of 62,000 jobs. The BLS revised downward its previous estimates of employment in February and March by a combined 16,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”)

The following figure from the jobs report shows the net change in nonfarm payroll employment for each month in the last two years. The figure shows an unusual pattern in the job market since the middle of 2025 in which months of declining employment and months of increasing employment have been alternating. March and April of 2026 are the first back-to-back months of increasing net employment since March and April of 2025.

These fluctuations of net employment gains around roughly zero are consistent with a recent analysis from economists at the Federal Reserve Bank of Dallas that estimates the break-even rate of employment growth—the rate of employment growth at which the unemployment rate remains constant. They note that “continued net outflows of unauthorized immigrants, together with shifts in labor force participation, have pushed the monthly break-even employment growth lower than previously thought.” They conclude that: “The break-even rate [of employment growth] peaked at about 250,000 jobs per month in 2023, fell to roughly 10,000 by July 2025, and declined to near zero thereafter, averaging about –3,000 jobs per month from August to December 2025, indicating, if anything, a modest net jobs loss over this period.” In other words, in the current labor market, the break-even rate of employment growth may actually be negative.

The unemployment rate, which is calculated from data in the household survey, was 4.3 percent in April, unchanged from March. As the following figure shows, the unemployment rate has been remarkably stable over the past year and a half, staying between 4.0 percent and 4.4 percent in each month since May 2024. The Federal Open Market Committee’s current estimate of the natural rate of unemployment—the normal rate of unemployment over the long run—is 4.2 percent. So, unemployment is slightly above that estimate of the natural rate. (We discuss the natural rate of unemployment in Macroeconomics, Chapter 9 and Economics, Chapter 19.)

As the following figure shows, the monthly net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. As measured by the household survey, there was a net decrease of 226,000 in April, the fourth consecutive month of decreases. (Note that because of last year’s shutdown of the federal government, there are no data for October or November.) In any particular month, the story told by the two surveys can be inconsistent. In this case, the establishment survey shows a strong increase in net employment, while the household survey shows a decline.

The household survey has another important labor market indicator: the employment-population ratio for prime age workers—those workers aged 25 to 54. In April the ratio was 80.7 percent, the same as in February and March. The prime-age population ratio remains above its value for most of the period since 2001. The continued high levels of the prime-age employment-population ratio indicate continuing strength in the labor market.

There have been media reports of firms, including Salesforce, Cloudflare, Coinbase, and Freshworks, laying off workers in information systems. The following figure shows net employment changes in the BLS employment category of “computing infrastructure providers, data processing, web hosting, and related services.” Employment in this sector declined for the sixth straight month in April. Since November 2025, the sector has experienced a net decline of 23,000 jobs.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.6 percent in April, up from 3.4 percent in March.

What effect is this jobs report likely to have on the decisions of the Federal Reserve’s policymaking Federal Open Market Committee at its next meeting on June 16–17, the first meeting with Kevin Warsh as chair? Although employment growth has been relatively slow in recent months, as noted earlier, even that slow rate may be close to the break-even rate of employment growth. So, it’s unlikely that the FOMC will see current conditions in the job market as warranting a cut in the committee’s target range for the federal funds rate. In addition, disruptions to the world oil market as a result of the conflict in Iran have caused oil prices to rise, putting upward pressure on the price level. And the effects of tariff increases have likely not yet fully passed through to increases in prices. These factors make it likely that the committee will keep its target range for the federal funds rate unchanged at its next meeting and may even begin considering future increases in the target range.

The probability that investors in the federal funds futures market assign to the FOMC keeping its target rate unchanged at its June meeting decreased slightly this afternoon to 93.9 percent, from 96.4 percent yesterday. Investors no longer assign a greater than a 50 percent probability to a rate cut occuring at any meeting through the end of 2027.

Two Releases from the BEA this Morning Show Steady GDP Growth and Rising Inflation

Image created by ChatGPT of the Department of Commerce building in Washington, DC

The Bureau of Economic Analysis (BEA) released two reports this morning: “GDP (Advance Estimate), 1st Quarter 2026” and “Personal Income and Outlays, March 2026.” The BEA estimates that real GDP grew at annual rate of 2.0 percent in the first quarter of 2026. That rate was up sharply from 0.5 percent in the fourth quarter of 2025, but below the 2.2 percent rate economists surveyed by the Wall Street Journal had forecast. The following figure shows the BEA’s estimated rates of GDP growth in each quarter beginning with the first quarter of 2022.

As the following figure—taken from the BEA report—shows, investment spending made the largest contribution to the growth of real GDP in the first quarter, with consumption spending growing at a slower rate than during the previous three quarters. Spending on imports grew significantly more than did spending on exports, resulting in net exports reducing real GDP growth by 1.3 percentage points.

As we’ve discussed in previous blog posts, to better gauge the state of the economy, policymakers—including Fed Chair Jerome Powell—often prefer to strip out the effects of imports, inventory investment, and government expenditures—which can be volatile—by looking at real final sales to private domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers increased by 2.5 percent at an annual rate in the first quarter, which was well above the 2.0 percent increase in real GDP and also above the U.S. economy’s expected long-run annual real growth rate of 1.8 percent. Note also that real final sales to private domestic purchasers grew by 2.9 percent in the third quarter of 2025, during which real GDP grew by 4.4 percent, and by 1.9 percent in the first quarter of 2025, when real GDP declined by 0.6 percent. So this measure of output is more stable and likely is a better indicator of the underlying growth rate in the economy than is growth in real GDP.

The BEA’s “Personal Income and Outlays” report this morning included monthly data on the personal consumption expenditures (PCE) price index. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2019, with inflation measured as the percentage change in the PCE from the same month in the previous year. In March, headline PCE inflation was 3.4 percent, up from 2.7 percent in February. Core PCE inflation in March was 3.2 percent, up from 3.0 percent in February. Both headline PCE inflation and core PCE inflation remained well above the Fed’s 2 percent annual inflation target.

The following figure shows monthly PCE inflation and monthly core PCE inflation calculated by compounding the current month’s rate over an entire year. (Often referred to as 1-month inflation.) Measured this way, headline PCE inflation soared to 9.2 percent in March, up from to 4.9 percent in February. Core PCE inflation fell to 3.6 percent in March from 5.2 percent in February. Even leaving aside the effect of rising gasoline prices on headline PCE, these data show that in March both core and headline PCE inflation were far above the Fed’s target.

Fed Chair Jerome Powell has frequently mentioned that inflation in non-market services can skew PCE inflation. Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices rise, the prices of financial services included in the PCE price index also rise. Powell has argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 3.4 percent in March, up from 2.9 percent in February. Core market-based PCE inflation was 3.1 percent in March, up from 2.9 percent in February. So, both market-based measures show inflation in March remaining well above the Fed’s 2 percent target.

Increases in rent have been one driver of inflation. The following figure shows the 12-month change in service prices, excluding energy and housing prices. Inflation in service prices measured this way was 3.5 percent in March. One-month inflation (not shown) was even higher at 4.6 percent.

However measured, inflation is clearly running well above the Fed’s 2 percent target. Incoming Fed Chair Kevin Warsh is walking into a difficult situation. He’s likely to come under pressure from President Trump to convince his colleagues on the Federal Open Market Committee to cut the target for the federal funds rate. But it seems unlikely that a majority of the committee would be willing to cut the target with inflation remaining well above 2 percent. As we mentioned in yesterday’s post, investors who buy and sell federal funds futures contracts don’t expect that the target rate will be lowered before the committee’s meeting on December 14–15 2027.

FOMC Holds Its Target for the Federal Funds Rate Constant as Powell Announces that He Intends to Remain on the BoG

Screenshot of Fed Chair Jerome Powell at his FOMC press conference on April 29

Today’s meeting of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) had the expected result with the committee deciding to leave unchanged its target for the federal funds rate at its current range of 3.50 percent to 3.75 percent. The members of the committee voted 8 to 4 in favor of the decision. Fed Governor Stephen Miran voted against the decision, preferring to lower the target range for the federal funds rate by 0.25 percentage point (25 basis points). Beth Hammack, president of the Federal Reserve Bank of Cleveland; Neel Kashkari, president of the Federal Reserve Bank of Minneapolis; and Lorie Logan, president of the Federal Reserve Bank of Dallas; supported keeping the target rate unchanged but “but did not support inclusion of an easing bias in the statement at this time.”

Perhaps the most significant news came at Chair Powell’s press conference at the conclusion of the meeting. Powell noted that Kevin Warsh’s nomination to be Fed chair had advanced out of the Senate Banking Committee this morning. Powell expected that Warsh would assume the role of chair by the time Powell’s term as chair ends on May 15. However, Powell announced that he would break with decades of tradition and remain on the Board of Governors. He noted that: “I have said that I will not leave the Board until this investigation [into his testimony before Congress concerning the renovations of the Fed’s headquarters building] is well and truly over, with transparency and finality, and I stand by that…. After my term as Chair ends on May 15, I will continue to serve as a governor for a period of time, to be determined. I plan to keep a low profile as a governor.” Powell’s term on the Board expires on January 31, 2028.

Powell will be the first Fed chair to remain on the Board after the end of his term as chair since Marriner Eccles continued to serve for three years after the end of his term as chair in 1948. The person whom the president has nominated as chair of the Board of Governors, once confirmed by the Senate, by tradition also serves as the chair of the FOMC. However, the Federal Reserve Act allows the FOMC to select its own chair. To head off any speculation that he might attempt to remain as chair of the FOMC, Powell stated at his press conference that: “When Kevin Warsh is confirmed and sworn, he will be that Chair. Once sworn in as Board Chair, his new colleagues will elect him to chair the FOMC as well.”

The FOMC has left its target for federal funds rate unchanged since lowering it by 25 basis points on December 10 of last year. The following figure shows for the period since January 2010, the upper bound (the blue line) and the lower bound (the green line) for the FOMC’s target range for the federal funds rate, as well as the actual values for the federal funds rate (the red line). Note that the Fed has been successful in keeping the value of the federal funds rate in its target range. (We discuss the monetary policy tools the FOMC uses to maintain the federal funds rate within its target range in Macroeconomics, Chapter 15, Section 15.2 (Economics, Chapter 25, Section 25.2).)

During his press conference, Powell discussed the reasons for the dissenting votes by Hammack, Kashkari, and Logan. The area of disagreement has to do with this sentence from the committee’s statement: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.” The three dissenters believe that the statement implies that the next change would likely be to lower the target range for the federal funds. They wished the language to be changed to communicate that the next change might also be to raise the target range. The four dissents were the most at an FOMC meeting since 1992.

Powell stated that he believed the current target range was mildly restrictive, which he believed was appropriate given that the economy was still experiencing strong output growth and that the labor market appears to be stable, while tariffs and rising oil prices are putting upward pressure on the price level.

When might the FOMC lower its target range for the federal funds rate? One indication of expectations of future changes in the FOMC’s target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. There are four more FOMC meeting scheduled for this year and for each meeting investors assign a probability of greater than 98 percent that the committee will either keep its target constant or raise it. For each meeting in 2027 until the last one on December 17–18, investors assign a probability of greater than 70 percent that the committee will keep its target constant or raise it. In other words, investors don’t believe that the target rate will be cut until the end of next year.

The next FOMC meeting will be on June 16–17. At that meeting, the committee is scheduled to release its quarterly Summary of Economic Projections (SEP), which includes a “dot plot” that represents each member’s expectations of future values of the federal funds rate. Warsh has questioned whether the SEP and the dot plot serve a good purpose and he may attempt to persuade the committee to abandon them. He has also questioned whether the chair should hold a press conference after every FOMC meeting as Powell has done since January 2019.

If Warsh does hold a press conference after the June meeting, his responses to questions will be closely analyzed for clues about the direction he intends to take the committee.

Glenn and Tony’s Excellent AI Adventure

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Many thanks to Matt O’Brien for producing this comic!

Glenn on Adam Smith and the Midterm Elections

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This opinion column was first published on Project Syndicate.

Adam Smith on the U.S. Midterms

The Wealth of Nations offers a useful lens for understanding why US President Donald Trump’s mercantilist agenda has fallen short of its own stated goals. It also points to a better path, combining competitive markets with policies that help workers and communities build skills and keep pace with economic change.

November’s midterm elections pose a serious challenge for US President Donald Trump. Key components of his economic agenda, especially its protectionist measures, have raised concerns about the rising cost of living, prompted a rare rebuke from the Supreme Court, and cast doubt on the legal basis for his tariffs. Fortunately for Trump and the Republicans, they still have time to pivot to a pro-growth agenda that better addresses voter anxieties before the midterms.

Trump’s agenda is rooted in voter concerns about economic disruption driven by technological change and globalization. Breaking with the bipartisan embrace of market-friendly policies, his administration has sought to shield US producers from competition. While Treasury Secretary Scott Bessent has hinted that a pivot to a pro-growth strategy is in the works, reconciling it with the administration’s mercantilist approach will be difficult.

There is, however, an alternative path that better aligns with Trump’s stated goal of helping people and communities buffeted by economic change. For guidance, it is worth turning to Adam Smith. The Wealth of Nations, published 250 years ago, grappled with many of the same tensions and pointed to a pragmatic middle ground.

At first glance, Smith may seem at odds with Trump’s approach. After all, The Wealth of Nations centers on Smith’s critique of the mercantilist order of his day. Mercantilism prizes trade surpluses and the accumulation of national wealth in the hands of the state. To work, it requires extensive government intervention in commerce, trade, and labor markets. But that expansive role invites rent-seeking and excessive control, a key concern for Smith.

Smith’s treatise turned this system on its head by posing a radical question: Where does national wealth come from? For Smith, the answer stood in contrast to mercantilism. A competitive economy, with limited government intervention, would be accompanied by openness and specialization, in turn raising living standards.

While Smith did not develop a formal theory of growth, his intuition about the importance of openness to markets and innovation is consistent with modern growth models and stands in contrast to Trump-era policymaking. As Nobel laureate economist Joel Mokyr has noted, science, practical knowledge, and openness to change are key drivers of long-term prosperity.

But Trump has also identified an important tension. Modern growth models are like a coin. The “heads” side is growth and its benefits for living standards; the “tails” side is disruption—the upending of existing investments, firms, jobs, and even communities. It is here that Trump’s mercantilism, with its focus on minimizing the effects of disruption on voters’ lives, gains political traction.

Smith challenges this perspective in two ways. First, he reminds us of the limits mercantilism places on living standards. Second, in The Theory of Moral Sentiments, which he considered his finest work, he emphasizes empathy and what my Columbia colleague Edmund S. Phelps calls “mass flourishing,” which aims to ensure that everyone benefits from economic progress, including those disrupted by its forward march.

Here, then, is the policy alternative to both Trumpian mercantilism and market orthodoxy: augmenting Smith’s concept of “competition” with the “ability to compete.” Such an agenda would center on preparation and reconnection, both vital for participation in—and support for—an open economy.

One place to begin is workforce development. In the United States, community colleges are well positioned to serve as training grounds for skill development and career transitions, often working closely with local employers to create quality jobs. While support for community colleges has declined in many states, a federal block grant focused on completion and skill development would significantly enhance their impact.

Similarly, a more generous Earned Income Tax Credit could boost labor-force participation and attachment. Increased funding for basic research, alongside support for applied research centers across the country, could raise productivity by bringing cutting-edge tools to businesses, much as land-grant colleges have historically done in agriculture and manufacturing.

To reconnect displaced workers, personal re-employment accounts—combining funds for training with re-employment bonuses—could help reduce the duration of joblessness. For communities affected by structural economic change, more effective place-based aid could support productivity-enhancing business services in lower-income areas with higher unemployment.

Such measures, along with a growth-oriented agenda, could reshape the electoral landscape. Investments in AI and electricity generation could be accelerated through regulatory reform, particularly by easing permitting rules under the National Environmental Policy Act. To increase the housing supply, a prerequisite for mobility and growth, the administration could propose incentives for state and local governments to scale back restrictive construction regulations.

Going further, the administration would need to abandon its nativist immigration policies. Increasing the number of high-skilled immigrants, particularly in STEM fields, would boost growth, as immigrants have been shown to drive technological innovation, leading to more patents, higher productivity, and rising incomes.

Likewise, expanding federal support for research and development would yield high returns. Some estimates suggest that the returns are so large that the net cost to taxpayers may be zero or even negative, as higher productivity generates enough additional tax revenue to offset the cost. Combined with a stable macroeconomic environment and pro-investment policies of the kind Trump has championed, these changes could significantly accelerate growth.

A more constructive approach to economic disruption would shift away from broad tariffs and protectionism, which tend to raise consumer prices and erode the competitiveness of US manufacturing by increasing input costs. The Supreme Court’s recent reversal of many tariffs imposed by Trump under the International Emergency Economic Powers Act has created an opportunity—and underscored the need—for a course correction.

Trump has rightly raised questions about the economic consequences of technological change and globalization. Two and a half centuries after its publication, The Wealth of Nations points toward a necessary pivot away from mercantilism and toward a more balanced, pro-growth framework.

Glenn’s Advice for Kevin Warsh

The Marriner S. Eccles building, headquarters of the Federal Reserve in Washington, DC. Image from federalreserve.gov.

The following opinion column appeared in the Financial Times.

What Warsh Should Do at the Fed

Donald Trump’s nomination of Kevin Warsh as chair of the Federal Reserve comes at a pivotal time for the American economy and for the US central bank. A pall has been cast by the administration’s unforced error of trumped-up charges against Jay Powell, the current Fed chair, and the president’s renewed threats to fire him if he does not leave by the end of his term. But the nominee’s credentials and experience ought to ensure a smooth confirmation. The question now should be what happens next.

The Fed faces three challenges. In the short term, the potential impact of the Iran war on employment calls for a careful assessment of the direction of the US economy. In the medium term, inflation continuing to run above the 2 per
cent target will limit the central bank’s room for maneuver, and also call its
credibility into question. In the longer term, questions remain about the
effectiveness of quantitative easing, the size of the Fed’s balance sheet, errors
made in the aftermath of the Covid pandemic, and the central bank’s forays
into areas better left to fiscal or regulatory policy.

All of which means that when Warsh eventually takes up the post, he should
launch an evaluation of the purpose, strategy and structure of the Fed straight
away.

First, purpose. The Federal Reserve was established as a lender of last resort
designed to mitigate financial crises. After it struggled to discharge that role
during the Great Depression, it turned to managing aggregate demand and
inflation. In 1978, Congress used the Humphrey-Hawkins Act to codify its
focus on inflation and employment, while giving the Fed leeway on how to
achieve those objectives. It also required the Fed chair to report to Congress on
its outcomes and outlook.

Warsh should now offer justifications for each of these objectives, set out
clearly what trade-offs they entail and how progress will be communicated.
This clarity focuses markets and elected officials on the importance of low and
steady inflation for US economic performance. And the advent of a new chair
provides an opportunity to make the Fed’s lender-of-last-resort decision-making clearer. Such explanations would be helpful in the present
environment of economic and public policy uncertainty.

Next comes strategy. This is about choosing a set of activities that deliver
objectives consistently. For the Fed, independence in monetary policy and the
ability to flex its balance sheet enable it to keep inflation low and manage
financial turmoil. Political assaults on its independence, of the type we have
recently seen, or restrictions on its balance sheet as a lender of last resort put
these strategic advantages at risk.

To deliver on purpose and strategy, the incoming chair should optimize the
Fed’s structure. The arrangement of a board of governors in Washington,
district banks led by district presidents, a Federal Open Market Committee of
the board and (a rotation of) five district presidents is set by law. But there are
three practical steps Warsh could take to improve the effectiveness of this setup.

First, the central bank should cast a wider net to gather insights from
economists, business leaders and financial market participants, with Fed
conferences reopened to members of these communities. Second, decisions
and direction should be communicated to financial markets and the public
consistently by the chair and by other officials.

Third, replace the notorious “dot plots”, which map FOMC members’
projections for the federal funds rate, with scenarios. Dot plots can be
misinterpreted as signals about the future path of interest rates. By contrast,
scenario analysis models how policy would respond to important changes, such
as shifts in AI investment, supply constraints, the natural rate of
unemployment, and medium-run effects on inflation, the dollar and US
economic activity from the conflict in Iran.

Such a comprehensive evaluation of purpose, strategy and structure would give
Warsh and the Fed both renewed organizational cohesion—and, more
importantly, a game plan.

On the perennial question of interest rates, the US economy’s near-term
momentum and elevated inflation are likely to tilt the balance of risks against
further cuts, despite Trump’s enthusiasm for an immediate cut. And while
Warsh is right to point out that the Fed should learn more about the economic
effects of AI, over the medium run a high-productivity-growth economy is
associated with a higher, not lower, real rate of interest.

Over this crucial period, the ability of the new chair to communicate clearly to
the public the value of low and steady inflation will be vital. The rules
governing the Fed’s role as lender of last resort should also be made clearer.
Finally, Warsh is correct that the Fed should take care to avoid engaging in the
kind of backdoor fiscal policy it has practiced in recent years.

Warsh is smart, informed, experienced in crisis management and an excellent
communicator. If the president allows him a free hand as chair, the American
economy should reap the benefits. Stay tuned.