Photo of Federal Reserve Chair Jerome Powell from federalreserve.gov.
As we discussed in a recent blog post, through the years a number of presidents have attempted to pressure Fed chairs to implement the monetary policy the president preferred. Although President Donald Trump nominated Jerome Powell to his first term as Fed chair—which began in February 2018—Trump has had many critical things to say about Powell’s conduct of monetary policy. Early in Trump’s current term, it seemed possible that he would attempt to replace Powell as Fed chair before the end of Powell’s second term in May 2026. Trump has stated, though, that he doesn’t intend to remove Powell. (As we discussed in this recent blog post, it seems unlikely that the Supreme Court would allow a president to remove a Fed chair because of disagreements over monetary policy.)
It’s not unusual for Fed chairs to meet with presidents, but until today (May 29) Powell had not met with Trump. When asked in a press conference on May 7 about a meeting with Trump, Powell responded that: “I don’t think it’s up to a Fed Chair to seek a meeting with the President, although maybe some have done so. I’ve never done so, and I can’t imagine myself doing that. It’s—I think it’s always—comes the other way: A President wants to meet with you. But that hasn’t happened.”
Today, Powell met with Trump after Trump requested a meeting. After the meeting, the Fed released this brief statement:
“At the President’s invitation, Chair Powell met with the President today at the White House to discuss economic developments including for growth, employment, and inflation.
Chair Powell did not discuss his expectations for monetary policy, except to stress that the path of policy will depend entirely on incoming economic information and what that means for the outlook.
Finally, Chair Powell said that he and his colleagues on the FOMC will set monetary policy, as required by law, to support maximum employment and stable prices and will make those decisions based solely on careful, objective, and non-political analysis.”
According to an article in the Wall Street Journal, following the meeting, White House Press Secretary Karoline Leavitt stated that:
“The president did say that he believes the Fed chair is making a mistake by not lowering interest rates, which is putting us at an economic disadvantage to China and other countries. The president has been very vocal about that both publicly—and now I can reveal—privately, as well.”
Image of an apartment house under construction generated by ChatGTP 4o.
In Chapter 1, we discuss one of our three key economic ideas: “People respond to economic incentives.” When government policymakers ignore this idea, government programs can fail to meet their goals as the following example shows.
In April 2024, to spur construction of new apartment houses, the New York state legislature enacted the Affordable Neighborhoods for New Yorkers program. The program includes what’s known as the 485-x tax break for apartment house builders. The details of the program are complex but basically a builder can have a new apartment house exempted from property taxes for up to 40 years provided that the building includes a specified number of apartments set aside for people with lower incomes. Some members of the state legislature believe that developers of larger apartment houses are typically better able to pay higher wages than are developers of smaller apartment houses. So, the legislation contained a provision that builders of projects with 100 or more units must pay construction workers at least $40 per hour.
An article in Crain’s New York Business reported today on newly released data on developers registering an interest in participating in the program. The developers proposed building 118 apartment houses. (The developers can register an interest in the program, but aren’t formally awarded the tax break until after the projects are finished.) None of the projects would have 100 or more units; three projects will have 99 units. Not too surprisingly, developers have responded to the law by building smaller apartment houses rather than larger apartment houses that would require them to pay higher construction wages. The higher wages are also required for any project built south of 96th Street in the New York City borough of Manhattan. Again, unsurprisingly, only 2 of the 118 proposed projects are located in that part of the city. Although it was not the intent of the state legislature, the law provided an economic incentive to build smaller apartment houses outside of Manhattan and builders responded to that incentive.
The article quotes the president of the Real Estate Board of New York (REBNY) as saying: “The absence of the larger projects we need at scale to meet the city’s production goals was identified early on by REBNY as a likely outcome of the new program design.”
The article is here, although a subscription may be required.
Glenn, along with co-authors Douglas Elmendorf of Harvard’s Kennedy School and Zachary Liscow of the Yale Law School, has written a new National Bureau of Economic Research working paper: “Policies to Reduce Federal Budget Deficits by Increasing Economic Growth”
Here’s the abstract:
Could policy changes boost economic growth enough and at a low enough cost to meaningfully reduce federal budget deficits? We assess seven areas of economic policy: immigration of high-skilled workers, housing regulation, safety net programs, regulation of electricity transmission, government support for research and development, tax policy related to business investment, and permitting of infrastructure construction. We find that growth-enhancing policies almost certainly cannot stabilize federal debt on their own, but that such policies can reduce the explicit tax hikes, spending cuts, or both that are needed to stabilize debt. We also find a dearth of research on the likely impacts of potential growth-enhancing policies and on ways to design such policies to restrain federal debt, and we offer suggestions for ways to build a larger base of evidence.
ChatGTP-4o image of customers at a teller’s window in a nineteenth century bank.
The United States has many more commercial banks than do other high-income countries. At the end of 2024, there were about 4,000 commercial banks in the United States. In contrast, in 2024, there were only 35 commercial banks in Canada, 20 in South Korea, and fewer than 400 in Japan, France, Germany, Spain, Switzerland, Norway, Sweden, and the United Kingdom.
But even 4,000 commercial banks is many fewer than the peak of 29,417 commercial banks in the United States in 1921. The following figure shows the number of commercial banks in the United States from 1781, when the Bank of North America became the first bank to operate in the United States, through 2024. The grey line shows the total number of banks; the blue line shows the number of state banks—banks with a charter from a state government; and the orange line shows the number of national banks—banks with a charter from the federal government.
A key to the rapid expansion in the number of banks in the United States—there were already 1,600 in 1861—was legislation in most states that restricted banks to a single location. Without the ability to operate branches and with travel slow and expensive, most banks collected deposits and made loans only to businesses and firms in a small geographical area. Research by David Wheelock of the Federal Reserve Bank of St. Louis has shown that in 1900, of the 12,427 commercial banks in the United States, only 87 had any branches. In addition, a series of federal laws limited the ability of banks to operate in more than one state. The most recent of these laws was the McFadden Act, which Congress passed in 1927. With their loans concentrated in one geographic area—and often in a single industry—unit banks were inefficient because they were exposed to greater credit risk. If a bank is located in a town in down-state Illinois where most local businesses depend on agriculture, a drought could force many farmers to default on loans, causing the bank to suffer heavy losses and possibly fail.
The figure shows a surge in the number of banks during the World War I period. The total number of banks rose from 24,308 in 1913 to 29,417 in 1921—an increase of 21 percent. Research by David Wheelock and Mathew Jaremski of Utah State University discusses the reasons for the sharp increase in the number of banks through 1921 and the rapid decline in the number of banks in the following years. World War I led to problems in European agriculture, which drove up agricultural prices worldwide. U.S. farmers responded by expanding production and new banks opened to meet farmers’ increased demand for credit. Newly opened banks were particularly aggressive lenders. When European agriculture revived following the end of the war in 1918, agricultural prices declined sharply and many farmers defaulted on their loans. As unit banks, the assets of many newly opened banks were highly concentrated in loans to local farmers. When defaults on these loans sharply increased, many banks failed.
The number of banks declined slowly through the 1920s, reflecting in part the continuing problems of U.S. agriculture during those years. The Great Depression, which began in August 1929, led to a series of bank panics that reduced the number of banks from 25,125 in 1928 to 13,949 in 1933.
Over time, legal restrictions on the size and geographic scope of banking were gradually removed. After the mid-1970s, most states eliminated restrictions on branching within the state. In 1994, Congress passed the Riegle–Neal Interstate Banking and Branching Efficiency Act, which allowed for the phased removal of restrictions on interstate banking. The 1998 merger of NationsBank, based in North Carolina, and Bank of America, based in California, produced the first bank with branches on both coasts.
Rapid consolidation in the U.S. banking industry has resulted from these regulatory changes. While in 1984, there were 14,496 commercial banks in the United States, in 2024, as noted earlier, there were only about 4,000. This consolidation is what we would expect in an industry with substantial economies of scale when firms are free to compete with each other. When an industry has economies of scale, firms that expand have a lower average cost of producing goods or services. This lower cost allows the expanding firms to sell their goods or services at a lower price than smaller rivals, driving them out of business or forcing them to merge with other firms. Because large banks have lower costs than smaller banks, they can offer depositors higher interest rates, offer borrowers lower interest rates, and provide investment advice and other financial services at a lower price. (We discuss many aspects of the history and economics of banking in Chapter 10 of Money, Banking, and theFinancial System.)
Even though over the past 30 years there has been tremendous consolidation in the U.S. banking industry, 4,000 banks is still many more banks than in most other countries. So, it seems likely that further consolidation will take place, and the number of banks will continue to dwindle.
Photo of Federal Reserve Chair Jerome Powell from federalreserve.gov
Can a president fire the chair of the Federal Reserve in the same way that presidents have been able to fire cabinet secretaries? President Donald Trump has had a contentious relationship with Fed Chair Jerome Powell. Powell’s term as Fed chair is scheduled to end in May 2026. At times, Trump has indicated that he would like to remove Powell before Powell’s term ends, although most recently he’s indicated that he won’t do so.
Does Trump, or any president, have the legal authority to replace a Fed chair before the chair’s term expires? As we discuss in Macroeconomics, Chapter 27 (Economics Chapter 17), according to the Federal Reserve Act, once a Fed chair is nominated to a four-year term by the president (President Trump first nominated Powell to be chair in 2017 and Powell took office in 2018) and confirmed by the Senate, the president cannot remove the Fed chair except “for cause.” As we’ve noted in previous blog posts, most legal scholars argue that a president cannot remove a Fed chair due to a disagreement over monetary policy.
But if the Fed is part of the executive branch of the federal government and the president is the head of executive branch, why shouldn’t the president be able to replace a Fed chair. Article I, Section II of the Constitution of the United States states that: “The executive Power shall be vested in a President of the United States of America.” The ability of Congress to limit the president’s power to appoint and remove heads of commissions, agencies, and other bodies in the executive branch of government—such as the Federal Reserve—is not clearly specified in the Constitution. In 1935, a unanimous Supreme Court ruled in the case of Humphrey’s Executor v. United States that President Franklin Roosevelt couldn’t remove a member of the Federal Trade Commission (FTC) because in creating the FTC, Congress specified that members could only be removed for cause. Legal scholars have presumed that the ruling in this case would also bar attempts by a president to remove members of the Fed’s Board of Governors because of a disagreement over monetary policy.
Earlier this year, the Trump administration fired a member of the National Labor Relations Board (NLRB) and a member of the Merit Systems Protection Board (MSPB). The members sued and an appeals court ordered the president to reinstate the members. The Trump administration appealed the order to the Supreme Court, which on Thursday (May 22) granted a stay of the order on the grounds that “the Government is likely to show that both the NLRB and MSPB exercise considerable executive power,” and therefore can be removed by the president, when the case is heard by the lower court. The ruling indicated that a majority of the Supreme Court is likely to overturn the Humphrey’s Executor precedent either in this case, if it ends up being argued before the court, or in a similar case. (The Supreme Court’s order is here. An Associated Press article describing the decision is here. An article in the Wall Street Journal discussing the issues involved is here.)
Does the Supreme Court’s ruling in this case indicate that it would allow a president to remove a Fed chair? The court explicitly addressed this question, first noting that attorneys for the two board members had argued that “arguments in this case necessarily implicate the constitutionality of for-cause removal protections for members of the Federal Reserve’s Board of Governors or other members of the Federal Open Market Committee.” But the majority of the court didn’t accept the attorneys’ argument: “We disagree. The Federal Reserve is a uniquely structured, quasi-private entity that follows in the distinct historical tradition of the First and Second Banks of the United States.” (We discuss the First and Second Banks of the United States in Money, Banking, and the Financial System, Chapter 10.)
We discuss the unusual nature of the Fed’s structure in Macroeconomics, Chapter 14, Section 14.4, where we note that Congress gave the Fed a hybrid public-private structure and the ability to fund its own operations without needing appropriations from Congress. Fed Chair Powell clearly agrees that the Fed’s structure distinguishes its situation from that of other federal boards and commissions. Responding to a question following a speech in April, Powell indicated that he believes that the Fed’s unique structure means that a president would not have the power to remove a Fed chair.
It’s worth noting that the statement the court issued had the limited scope of staying the appeals court’s ruling that the members of the two commissions be reinstated. If a case arises that addresses directly the question of whether presidents can remove Fed chairs, it’s possible that, after hearing oral and written arguments, some of the justices may change their minds and decide that the president has that power. It wouldn’t be unusual for justices to change their minds during the process of deciding a case. But for now it appears that the Supreme Court would likely not allow a president to remove a Fed chair.
Since 1946, the Institute for Social Research (ISR) at the University of Michigan has conducted surveys of consumers. Each month, the ISR interviews a nationwide sample of 900 to 1,000 consumers, asking a variety of questions, including some on inflation.
The results of the University of Michigan surveys are widely reported in the business press. In the latest ISR survey it’s striking how much consumers expect inflation to increase. The median response by those surveyed to the question “By about what percent do you expect prices to go up/down on the average, during the next 12 months?” was 7.3 percent. If this expectation were to prove to be correct, inflation, as measured by the percentage change in the consumer price index (CPI), will have to more than double from its April value of 2.3 percent.
How accurately have consumers surveyed by the ISR predicted future inflation? The question is difficult to answer definitively because the survey question refers only to “prices” rather than to a measure of the price level, such as the consumer price index (CPI). Some people may have the CPI in mind when answering the question, but others may think of the prices of goods they buy regularly, such as groceries or gasoline. Nevertheless, it can be interesting to see how well the responses to the ISR survey match changes in the CPI, which we do in the following figure for the period from January 1978—when the survey began—to April 2024—the last month for which we have CPI data from the month one year in the future.
The blue line shows consumers’ expectations of what the inflation rate will be over the following year. The red line shows the inflation rate in a particular month calculated as the percentage change in the CPI from the same month in the previous year. So, for instance, in February 2023, consumers expected the inflation rate over the next 12 months to be 4.2 percent. The actual inflation, measured as the percentage change in the CPI between February 2023 and February 2024 was 3.2 percent.
The figure shows that consumers forecast inflation reasonably well. As a simple summary, the average inflation rate consumers expected over this whole period was 3.6 percent, while the actual inflation rate was 3.5 percent. So, for the period as a whole, the inflation rate that consumers expected was about the same as the actual inflation rate. The most persistent errors occurred during the recovery from the Great Recession of 2007–2008, particularly the five years from 2011 to 2016. During those five years, consumers expected inflation to be 2.5 percent or more, whereas actual inflation was typically below 2 percent.
Consumers also missed the magnitude of dramatic changes in the inflation rate. For instance, consumers did not predict how much the inflation would increase during the 1978 to 1980 period or during 2021 and early 2022. Similarly, consumers did not expect the decline in the price level from March to October 2009.
The two most recent expected inflation readings are 6.5 percent in April and, as noted earlier, 7.3 percent in May. In other words, the consumers surveyed are expecting inflation in April and May 2026 to be much higher than the 2 percent to 3 percent inflation rate most economists and Fed policymakers expect. For example, in March, the median forecast of inflation at the end of 2026 by the members of the Fed’s policymaking Federal Open Market Committee (FOMC) was only 2.2 percent. (Note, though, that FOMC members are projecting the percentage change in the personal consumption expenditures (PCE) price index rather than the percentage change in the CPI. CPI inflation has typically been higher than PCE inflation. For instance, in the period since January 1978, average CPI inflation was 3.6 percent, while average PCE inflation was 3.1 percent).
If economists and policymakers are accurately projecting inflation in 2026, it would be an unusual case of consumers in the ISR survey substantially overpredicting the rate of inflation. One possibility is that news reports of the effect of the Trump Administration’s tariff policies on the inflation rate may have caused consumers to sharply increase the inflation rate they expect next year. If, as seems likely, the tariff increases end up being much smaller than those announced on April 2, the inflation rate in 2026 may be lower than the consumers surveyed expect.
Image generated by ChatGTP-4o of a family shopping in a supermarket.
Today (May 13), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for April. The following figure compares headline inflation (the blue line) and core inflation (the green line).
The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous year, was 2.3 percent in April—down from 2.4 percent in March.
The core inflation rate,which excludes the prices of food and energy, was 2.8 percent in April—unchanged from March.
Headline inflation was the lowest since February in 2021—before the acceleration in inflation that began in the spring of 2021. Core inflation was the lowest since March 2021. Both headline inflation and core inflation were what economists surveyed 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) rose from –0.6 percent in March to 2.7 percent in April. Core inflation (the red line) rose from 0.9 percent in March to 2.9 percent in April.
The 1-month and 12-month inflation rates are telling different stories, with 12-month inflation indicating that the rate of price increase is back to what it was in early 2021. The 1-month inflation rate indicates a significant increase in April from the very low rate of price increase in March. The 1-month inflation rate indicates that inflation is still running ahead of the Fed’s 2 percent annual inflation target.
Of course, it’s important not to overinterpret the data from a single month. The figure shows that 1-month inflation is particularly volatile. It is possible, though, that the increase in 1-month inflation in April reflects the effect on the price level of the large tariff increases the Trump Administration announced on April 2. Whether those effects will persist is unclear because the administration has been engaged in negotiations that may significantly reduce the tariff increases announced in April. Finally, note that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI, to evaluate whether it is hitting its 2 percent annual inflation target.
There’s been considerable discussion in the media about continuing inflation in grocery prices. The following figure shows inflation in the CPI category “food at home,” which is primarily grocery prices. Inflation in grocery prices was 2.0 percent in April and has been below 2.5 percent every month since September 2023. Over the past year, there has been a slight upward trend in inflation in grocery prices but to this point it remains relatively low, although well above the very low rates of inflation in grocery prices that prevailed from 2015 to 2019.
It’s the nature of the CPI that in any given month some prices will increase rapidly while other prices will increase slowly or even decline. Although, on average, grocery price inflation has been relatively low, there have been substantial increases in the prices of some food items. For instance, a recent article in the Wall Street Journal noted that rising cattle prices will likely be reflected in coming months rising prices for beef purchased in supermarkets. The following figure shows inflation in the prices of ground beef and steaks over the period starting in January 2015. As we should expect, the prices of these two goods are more volatile mont to month than are grocery prices as a whole. Ground beef prices increased 10.8 percent in April, an increase that will likely be noticeable to someone planning for a Memorial Day cookout.
To better estimate the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.
Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is 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.
Trimmed-mean 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.
The following figure shows that 12-month trimmed-mean inflation (the blue line) was 3.0 percent in April, unchanged from March. Twelve-month median inflation (the red line) 3.5 percent in April, also unchanged from March.
The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation increased from 2.6 percent in March to 3.0. percent in April. One-month median inflation declined from 4.2 percent in March to 4.0 percent in April. These data, although mixed, provide some confirmation that inflation likely increased somewhat from March to April.
What are the implications of this CPI report for the actions the FOMC may take at its next several meetings? Investors who buy and sell federal funds futures contracts still do not expect that the FOMC will cut its target for the federal funds rate at its next two meetings. (We discuss the futures market for federal funds in this blog post.) Today, investors assigned only an 8.4 percent probability to the Fed’s policymaking Federal Open Market Committee (FOMC) cutting its target from the current 4.25 percent to 4.50 percent range at its meeting on June 17–18. Investors assigned a probability of 34.9 percent that the FOMC will cut its target after its meeting on July 29–30. Investors assigned a probability of 73.1 percent that the committee will cut its target after its meeting on September 16–17. The FOMC’s actions will likely depend in part on the success of the current trade negotiations.
The economy and financial markets nervously await the July 8 end of the 90-day pause of the Trump administration’s “reciprocal” tariffs. But four days earlier, Republicans can allay those fears with a pro-growth policy that advances President Trump’s Made in America agenda without tariffs. The fix: tax reform.
July 4 is the date that Treasury Secretary Bessent has predicted Congress and the White House will have ready a 2.0 version of the landmark Tax Cut and Jobs Act of 2017, or TCJA. Without congressional action, some of these reforms will expire at the end of 2025, killing changes that still benefit the economy. Corporate tax changes, in particular, boosted investment and growth. These should remain the focal point of this next tax bill—for many reasons. Done right, corporate tax reform could advance President Trump’s goal to bring investment to American production without using economy-roiling tariffs. Call it TCJA+.
Renewing some parts of the original TCJA will help investment in the U.S. The 2017 reform offered incentives for investment in new businesses by allowing them to expense the cost of assets, rather than writing them off over time. But these benefits were set to be phased out from 2023 to 2026, removing a key pro-growth element of the earlier law.
Then there are two new provisions Republicans should add to secure Mr. Trump’s goal to have more made in America. Both were in the original 2016 House Republican tax reform blueprint.
First, Congress should change business taxation from the current income tax to a cash-flow tax, which taxes a firm’s revenue, minus all its expenses, including investment. Long championed by economists and tax-law experts, a cash-flow tax would allow businesses to expense investment immediately. It would also disallow nonfinancial companies from making interest deductions, because unlike an income tax, a cash-flow tax treats debt and equity the same. This removes an important tax incentive for firms to allow themselves to be leveraged. A cash-flow tax is also much simpler than a corporate income tax, which requires complex depreciation schedules. Most important, the reform would stimulate business investment.
Second, legislators should add a border adjustment to corporate taxes. That would deny companies a tax deduction for expenses of inputs imported from abroad, while exempting U.S. exports from taxation. As the Trump administration has observed, other countries already use border adjustments in their value-added taxes on consumption. America uses a similar mechanism in state and local retail taxes, too. If you buy a kitchen appliance in New York, you pay New York sales tax, even if it was made in Ohio. Sales tax applies only where the good is sold, not where it originates.
Though distinct from tariffs, border adjustments can promote domestic production. Adding a border adjustment to the federal corporate tax would eliminate any extra tax businesses suffer now simply as a consequence of producing in the U.S. Though the 2017 law made the U.S. tax system more globally competitive by lowering the corporate income tax rate from 35% to 21%, it’s still higher than in many other countries, which attract production with low cost. A border adjustment would remove this incentive for American firms to locate profits or activities abroad, while increasing incentives for non-U.S. firms to locate activities within our borders.
As with the original pro-investment features in the 2017 law, this TCJA+ reform would increase investment and incomes—and thereby revenue. For the original TCJA, when the Congressional Budget Office included the macroeconomic effects of higher incomes buoyed by the reforms’ pro-growth elements, the CBO reduced the estimated revenue loss from the tax cuts by almost 30%. Changing the corporate income tax to a cash-flow levy would similarly increase revenue by removing taxes on what economists call the “normal return” on investment, or the cost of capital. Companies would instead pay only on profits above this amount. A border adjustment can likewise raise substantial revenue over the next decade because imports (which would receive no deduction) are larger than exports (which would no longer be taxed).
The higher revenue these two TCJA+ provisions promise could be used to lower the tax rate on business cash flow or to fund other tax-policy objectives. Importantly, that revenue can replace revenue raised from the tariffs the Trump administration had planned to implement on July 8. These two tax provisions would accomplish the president’s America-first and revenue objectives without destabilizing businesses with whipsawing tariffs.
Finally, TCJA+ would offer another big benefit: It would move the U.S. toward independence from political meddling in the economy via targeted protection or subsidies. This added predictability and breathing room for investment would be one more reason to produce in America. Pluses indeed.
Fed Chair Jerome Powell speaking at a press conference following a meeting of the FOMC (photo from federalreserve.gov)
Members of the Fed’s policymaking Federal Open Market Committee (FOMC) had signaled clearly before today’s (May 7) meeting that the committee would leave its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent. In the statement released after its meeting, the committee made one significant change to the wording in its statement following its last meeting on March 19. The committee added the words in bold to the following sentence:
“The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”
The key event since the last FOMC meeting was President Trump’s announcement on April 2 that he would implement tariff increases that were much higher than had previously been expected.
As we noted in an earlier blog post, an unexpected increase in tariff rates will result in an aggregate supply shock to the economy. As we discuss in Macroeconomics, Chapter 13,Section 13.3 (Economics, Chapter 23, Section 23.3), an aggregate supply shock puts upward pressure on the price level at the same time as it causes a decline in real GDP and employment. The result, as the FOMC statement indicates, can be both rising inflation and rising unemployment. If higher inflation and higher unemployment persist, the U.S. economy would be experiencing stagflation. The United States last experienced stagflation during the 1970s when large increases in oil prices caused an aggregate supply shock.
During his press conference following the meeting, Fed Chair Jerome Powell indicated that the increase in tariffs might the Fed’s dual mandate goals of price stability and maximum employment “in tension” if both inflation and unemployment increase. If the FOMC were to increase its target for the federal funds rate in order to slow the growth of demand and bring down the inflation rate, the result might be to further increase unemployment. But if the FOMC were to cut its target for the federal funds rate to increase the growth of demand and reduce the unemployment rate, the result might be to further increase the inflation rate.
Powell emphasized during his press conference that tariffs had not yet had an effect on either inflation or unemployment that was large enough to be reflected in macroeconomic data—as we’ve noted in blog posts discussing recent macroeconomic data releases. As a result, the consensus among committee members is that it would be better to wait to future meetings before deciding what changes in the federal funds rate might be needed: “We’re in a good position to wait and see. We don’t have to be in a hurry.”
The following figure shows, for the period since January 2010, the upper bound (the blue line) and lower bound (the green line) for the FOMC’s target range for the federal funds rate and the actual values of the federal funds rate (the red line) during that time. Note that the Fed is 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 in its target range in Macroeconomics, Chapter 15, Section 15.2 (Economics, Chapter 25, Section 25.2).)
In his press conference, Powell indicated that when the committee would change its target for the federal funds rate was dependent on the trends in macroeconomic data on inflation, unemployment, and output during the coming months. He noted that if both unemployment and inflation significantly increased, the committee would focus on which variable had moved furthest from the Fed’s target. He also noted that it was possible that neither inflation nor unemployment might end up significantly increasing either because tariff negotiations lead to lower tariff rates or because the economy proves to be better able to deal with the effects of tariff increases than many economist now expect.
One indication of expectations of future changes in the target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) The data from the futures market indicate that investors don’t expect that the FOMC will cut its target for the federal funds rate at its May 17–18 meeting. As shown in the following figure, investors assign a 80.1 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at that meeting.
When will the Fed likely cut its target for the federal funds rate? As the following figure shows, investors expect it to happen at the FOMC’s July 29–30 meeting. Investors assign a probably of 58.5 percent to the committee cutting its target by 0.25 percentage point (25 basis points) at that meeting and a probability of 12.7 percent to the committee cutting its target by 50 basis points. Investors assign a probability of only 28.8 percent to the committee leaving its target unchanged.
Image created by ChatGTP=4o of workers on an automobile assembly line.
We noted in a blog post earlier this week that although the preliminary estimate from the Bureau of Economic Analysis (BEA) indicated that real GDP had declined during the first quarter of 2025, the report didn’t provide a clear indication that the U.S. economy was in recession. This morning (May 2), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for April. The data in the report also show no sign that the U.S. economy is in a recession. Although there have been many stories in the media about businesspeople becoming increasingly pessimistic, we don’t yet see it in the employment data. We should add two caveats, however: 1. The effects of the large tariff increases the Trump Administration announced on April 2 are likely not reflected in the data from this report, and 2. at the beginning of a recession the data in the jobs report can be subject to large revisions.
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 data 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 177,000 jobs during April. This increase was well above the increase of 135,000 that economists surveyed had forecast. Somewhat offsetting this unexpectedly large increase was the BLS revising downward its previous estimates of employment in February and March by a combined 58,000 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 payroll employment for each month in the last two years.
The unemployment rate was unchanged to 4.2 percent in April. As the following figure shows, the unemployment rate has been remarkably stable over the past year, staying between 4.0 percent and 4.2 percent in each month since May 2024. In March, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.4 percent.
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 increase of 436,000 jobs in April, following an increase of 201,000 jobs in March. As an indication of the volatility in the employment changes in the household survey note the very large swings in net new jobs in January and February. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. This month, however, both surveys showed net jobs increasing. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)
The household survey has another indication of continuing strength in the labor market. The employment-population ratio for prime age workers—those aged 25 to 54—increased from 80.4 percent in March to 80.7 percent in April. The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is above what the ratio was in any month during the period from January 2008 to January 2020.
It remains unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in total federal government employment of 9,000 in April. However, the BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.” It’s possible that as more federal employees end their period of receiving severance pay, future jobs reports may find a more significant decline in federal employment. To this point, the decline in federal employment has been too small to have a significant effect on the overall labor market.
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 3.8 percent in April, which is unchanged from the March increase.
The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month wage inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic. The April, the 1-month rate of wage inflation was 2.0 percent, down from 3.4 percent in March. If the 1-month increase in AHE is sustained, it would contribute to the Fed’s achieving its 2 percent target rate of price inflation.
Today’s jobs report leaves the situation facing the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) largely unchanged. Looming over monetary policy, however, is the expected effect of the Trump Administration’s unexpectedly large tariff increases. As we note in this blog post, a large unexpected increase in tariffs results in an aggregate supply shock to the economy. In terms of the basic aggregate demand and aggregate supply model that we discuss in Macroeconomics, Chapter 13 (Economics, Chapter 23), an unexpected increase in tariffs shifts the short-run aggregate supply curve (SRAS) to the left, increasing the price level and reducing the level of real GDP.
One indication of expectations of future changes in the target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) The data from the futures market indicate that, despite the potential effects of the surprisingly large tariff increases, investors don’t expect that the FOMC will cut its target for the federal funds rate at its May 6–7 meeting. As shown in the following figure, investors assign a 98.2 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at that meeting.
It’s a different story if we look at the end of the year. As the following figure shows, investors now expect that by the end of the FOMC’s meeting on December 9-10, the committee will have implemented at least three 0.25 percentage point (25 basis points) cuts in its target range for the federal funds rate. Investors assign a probability of 75.9 percent that the target range will end the year at 3.50 percent to 3.75 percent or lower. At their March meeting, FOMC members projected only two 25 basis point cuts this year—but that was before the announcement of the unexpectedly large tariff increases.
How the economy will fare for the remainder of the year depends heavily on what happens with respect to tariffs. News today that China and the United States may be negotiating lower tariff rates has contributed to rising stock prices. The following figure from the Wall Street Journal shows movements in the S&P stock index over the past year. The index declined sharply on April 2, following President Trump’s announcement of the tariff increases. As of 2 pm today, the S&P index has risen above its value on April 1, meaning that it has recovered all of the losses since the announcement of the tariff increases. The increase in stock prices likely indicates that investors expect that the tariff increases will end up being much smaller than those originally announced and that the chances of a recession happening soon are lower than they appeared to be on April 2.
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