Students are already asking about AI, and Glenn Hubbard and Tony O’Brien have the economics to answer them. The authors connect today’s headlines to the principles you teach every semester: whether AI will raise or displace wages, why entrepreneurs like NVIDIA’s Jensen Huang matter but aren’t irreplaceable, how national security shapes chip regulation, and why long-term interest rates are rising. They also take up fiscal dominance and the Fed’s independence, making this a timely source of real-world examples for your macroeconomics and money and banking lectures.
Category: Ch28: Macroeconomics in an Open Economy
FOMC Votes with Two Dissents to Keep Its Target for the Federal Funds Rate Unchanged
Photo of Fed Chair Kevin Warsh from federalreserve.gov
Today, the Federal Open Market Committee (FOMC) met expectations by keeping its target range for the federal funds rate unchanged at 3.75 percent to 4.00 percent. As of yesterday, trading in the federal funds rate futures market had implied a 93.4 percent probability that the target range would be unchanged. Fed Governor Lisa Cook and Federal Reserve Bank of Cleveland President Beth Hammack dissented from the vote, preferring that the target range be increased by 0.25 percentage points (25 basis points). Hammack had also dissented at the July FOMC meeting in favor of a target range increase. Cook had not previously dissented from the majority at any meeting.
At his press conference following the meeting, Fed Chair Kevin Warsh said that political considerations did not play a role in the FOMC’s decision to leave the target range unchanged. As we noted in this earlier blog post, some analysts believe that the committee was reluctant to raise the target range so close to Tuesday’s midterm elections.
The following figure shows for the period since 2001, 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). Before December 2008, the Fed announced a single numerical target for the federal funds rate, rather than a target range. 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).)
As with the policy statements issued following Warsh’s previous three FOMC meetings, today’s policy statement was short and did not include any discussion of the specific circumstances under which further target range increases might occur—so-called forward guidance. We discuss forward guidance in Macroeconomics, Chapter 15 (Economics, Chapter 25).
At his press conference following the meeting, as he typically does, Warsh resisted attempts by reporters to get him to expand on the circumstances under which the committee might implement further increases in the target range. He reiterated his belief that the Fed was currently meeting its Congressional mandate for maximum employment but had not yet met its mandate for price stability by bringing inflation back to an annual rate of 2 percent.
He did note that the period between now and the next FOMC meeting on December 8–9 would be “information rich,” presumably because there will be additional data releases on inflation and unemployment during that time. In addition, the committee might have greater clarity about what Warsh referred to as “geopolitical factors,” such as the conflict in the Middle East.
Warsh also announced at the press conference that, beginning in fall 2027, the FOMC will devote one of its eight annual meetings to discussing monetary policy strategy. In 2028, the FOMC may devote two of its eight meetings to discussing monetary policy strategy. There would be no vote on the federal funds rate target range at these meetings, and he expected that the committee would not release a policy statement. It was unclear whether he intends to hold a press conference following these meetings. If implemented, this plan would result in longer periods during which the public would not be receiving formal updates on monetary policy.
What’s Going on in the Bond Market?
Image created by ChatGPT
As the following figure show, as of yesterday, the yield on the 30-year U.S. Treasury bond is the highest it’s been since 2004, before the Global Financial Crisis.
The following figure (created by ChatGPT using data from this Treasury website) shows that Treasury bonds at all maturities have risen this year. Recall that the maturity of a bond is the amount of time until the seller of the bond repays the principal to the buyer of the bond. Formally, a Treasury security with a maturity of 1 year or less is a Treasury bill, a Treasury security with with a maturity of 2 years to 10 years is a Treasury note, and a Treasury security with of more than 10 years is a Treasury bond. For simplicity, in this post we’ll usually refer to all Treasury securities as bonds. We’ll refer interchangeably to the interest rate on a bond and the yield on the bond. Formally, the relevant interest rate in this post is the yield to maturity. (We discuss the bond market in Money, Banking, and the Financial System, Chapters 3-5. A new edition is available now.)
Rising yields on Treasury securities have a substantial effect on the economy. On most days, nearly all of the buying and selling in the Treasury bond market is of existing bonds that the U.S. Treasury may have issued decades earlier. Because the federal government has been running large budget deficits, the Treasury has to issue billions of new Treasury bonds each year. Investors will only buy newly issued Treasury bonds if their yields are competitive with the yields on existing bonds. As a result, interest payments have been a rising fraction of total federal spending, which contributes to the federal budget deficit.
Firms that grant mortgage loans typically adjust the interest rates they charge as the yield on the 10-year Treasury changes. The difference between the interest rate on mortgages and the interest rate on the 10-year Treasury is called the mortgage spread. The following figure shows the close relationship between movements in the mortgage interest rate (the blue line) and movements in the interest rate on 10-year Treasurys (the red line). The recent increase in the yields on 10-year Treasurys has caused an increase in the mortgage interest rate.
Many investors hold both Treasury bonds and bonds issued by corporations. If the yields on Treasury bonds rise, to attract investors the yields on corporate bonds also have to rise. The following figure shows that there is a close relationship between the yield on 10-year Treasurys and the yield on corporate bonds. The interest rate on corporate bonds is higher than the interest rate on Treasurys for two key reasons: First, corporate bonds have a higher default risk, which is the risk that a bond issuer will fail to make payments of interest or principal. Second., corporate bonds are less liquid than Treasurys, which means that because the market for Treasurys is much larger than the market for any corporate bond, an investor can more easily sell a Treasury bond. Investors need to be compensated with a higher interest rate on corporate bonds for the greater default risk and lower liquidity of these bonds.
What’s caused the increases in interest rates? Several factors are involved. First, in part because of rising oil prices resulting from conflict in the Middle East, since the middle of 2026 there has been an increase in the inflation rate that investors in bond markets expect to prevail over the next few years. Inflation reduces the purchasing power of the payments investors receive from owning a bond. The Fisher effect refers to the argument by Irving Fisher, who was an economist at Yale University, that the nominal interest rate on a bond will rise point-for-point with changes in the expected inflation rate. (Recall from Macroeconomics, Chapter 9 (Economics, Chapter 19) that the nominal interest rate is the stated interest rate on a bond. We can approximate the real interest rate by subtracting the expected inflation rate from the nominal interest rate.) The following figure from Chapter 4 of Money, Banking, and the Financial System, illustrates the Fisher effect.
A higher expected inflation rate increases the quantity of bonds supplied at any given bond price because inflation reduces the real value of the payments that bond issuers have to make. In the figure, the supply curve for bonds shifts to the right from S1 to S2. A higher expected inflation rate decreases the quantity of bonds demand at any given bond price because inflation reduces the real value of the payments that bond buyers receive. The demand curve for bonds shift to the left from D1 to D2. Note that because the equilibrium price of bonds declines from P1 to P2, the interest rate—which moves inversely with the price—increases. In practice, economists have found that various real-world frictions result in nominal interest rates not always increasing or decreasing by exactly the amount of a change in expected inflation. But the basic point holds that changes in the expected inflation rate lead to changes in the interest rates on bonds.
The second reason that interest rates have been rising is related to the first reason. As we discuss in this blog post, because the inflation rate has been running persistently higher than the Federal Reserve’s 2 percent annual target, at its September meeting the Fed’s Federal Open Market Committee (FOMC) raised its target for the federal funds rate. Investors in the federal funds futures market expect that the committee will raise its federal funds rate target further in coming meetings. The following figure shows that the interest rate on 1-year Treasury bills tracks closely movements in the federal funds rate.
Changes in expected future short-term interest rates, such as the expected interest rate on the 1-year Treasury bill one year from now, can affect longer-term interest rates. For example, someone who wants to invest in Treasurys for two years could either buy a 2-year Treasury or buy a 1-year Treasury today and another 1-year Treasury in a year. We would expect that buying and selling in the bond market would make the return from these two ways of investing equal—a process called arbitrage. If investors expect that the FOMC will raise its target for the federal funds rate in the future, the expected interest on the 1-year Treasury bill a year from now will increase, which will also increase the interest rate today on a 2-year Treasury. The same process will also cause interest rates on longer-maturity bonds to increase.
Third, the supply of bonds has been increasing rapidly. As we’ve seen, high federal government budget deficits will cause the Treasury to issue close to $2 trillion in bonds this year. In addition, technology firms, such as as Meta, Alphabet (the parent company of Google), Amazon, and Oracle, have been increasing their bond sales to obtain the funds to build out the infrastructure, such as data centers, necessary to power the AI build out. According to data from the Securities Industry and Financial Markets Association, through August of 2026, corporate bond issuance was nearly 30 percent greater than in 2025.
(Note that most other high income countries, including Japan, Canada, and the countries of Western Europe, have also been running large government budget deficits and issuing large quantities of bonds. Because investors can buy and sell bonds across countries, higher interest rates in one country can put upward pressure on interest rates in other countries.)
As the following figure shows, an increase in the supply of bonds, holding other factors that can affect the demand or supply of bonds constant, causes the price of bonds to fall and, therefore, the interest rate on bonds to rise.
Following the Global Financial Crisis of 2007–2009, low inflation rates and a federal funds rate close to zero resulted in low interest rates on most bonds. For example, the 10-year Treasury note was below 4 percent—and typically below 3 percent—from late 2008 to late 2022. Some economists believed that interest rates would remain low for the foreseeable future. But the sharp increase in inflation rates that began in the spring of 2021, following the Covid pandemic, continuing high federal budget deficits, and tech firms demand for funds to build data centers and other AI infrastructure has led to the highest interest rates in more than 20 years. Whether these high interest rates will persist depends primarily on future inflation rates and future federal budget deficits.
Canadian Prime Minster Mark Carney, Meet Canadian Prime Minister R. B. Bennett
Image created by ChatGPT
The United States and Canada have a long history of friendly relations and, famously, share the longest undefended border in the world. Trade in goods and services has also linked the two countries with substantial economic benefits to both. By and large, trade flows reflect each country’s comparative advantage in producing goods and services. (We discuss the important role of comparative advantage in international trade in Microeconomics, Chapter 9 (Economics, Chapter 9 and Macroeconomics, Chapter 7).)
Image created by ChatGPT
The following figures show that in 2025, Canada was the leading market for U.S. exports and the second leading source of U.S. imports, behind only Mexico.
The two figures were prepared by ChatGPT using data from the U.S. Bureau of Economic Analysis.
Beyond trade in final goods and services, a number of U.S. and Canadian firms rely on capital goods and intermediate goods produced in the other country. For instance, in 2025, U.S. automobile manufacturers imported auto parts worth $19.5 billion from Canada. In other words, the supply chains of these firms rely on Canadian-produced parts.
Image created by ChatGPT
Economic relations between the United States and Canada have not always been smooth, however. In particular, the substantial increases in U.S. tariff rates in 1930 and during the second Trump administration resulted in sharp reactions from the Canadian government.
In 1930, Congress passed and President Herbert Hoover signed into law the Smoot-Hawley Tariff. In retaliation, Canadian Prime Minister William Lyon Mackenzie King and the Liberal Party significantly raised tariffs on U.S. imports. (We discussed the Smoot-Hawley Tariff in this blog post last year.) In the July 1930 Canadian elections, as the effects of the Great Depression began to be felt, Richard Bedford Bennett, the leader of the Conservative Party campaigned on using tariff increases to increase production and reduce unemployment. In a campaign speech, Bennett argued, “You have
been taught to mock at tariffs and applaud free trade. Tell me, when did free
trade fight for you? You say our tariffs are only for the manufacturers; I will
make them fight for you as well. I will use them to blast a way into the markets
that have been closed to you.”
Photo of Congressman Willis Hawley of Oregon and Senator Reed Smoot from the U.S. Library of Congress via the Wall Street Journal.
The Conservatives won an overwhelming victory in the 1930 election, and the Canadian Parliament passed legislation that raised Canadian tariff rates on U.S. imports to the highest levels in history. Bennett hoped that Canada could replace the decline in exports to the United States with an increase in exports to the United Kingdom. The following two figures, from an academic paper Tony published with his Lehigh colleague Judith MacDonald, indicate the unlikelihood of Bennett’s plan succeeding. For most of the twentieth century up to 1930 (with the exception of the World War I period), the share of Canadian exports that went to the United Kingdom had been declining, while the share that went to the United States had been increasing. In addition, in 1930, more than 60 percent of Canadian imports came from the United States as opposed to less than 20 percent coming from the United Kingdom.
For reasons of geography and the long-established trading relations between U.S. and Canadian firms, a major reorienting of Canada’s trade away from the United States and toward the United Kingdom wasn’t feasible. By 1935, near the end of his five-term, Bennett pivoted to attempting to negotiate a reciprocal trade agreement with the United States that would result in both countries reducing their tariffs on each other’s products. An agreement was reached in November 1935, but that was too late for Bennett who had been voted out of office in July.
The higher tariffs that the Trump administration has imposed on Canadian imports has placed Canadian Prime Minister Mark Carney in a situation similar to that Bennett faced in 1930. Like Bennett, Carney has responded to the higher tariffs by increasing tariffs on imports from the United States. And like Bennett, Carney has tried to find new markets outside of the United States for Canadian exports. According to an article in the Wall Street Journal:
“Carney has instructed his special envoy to Europe to scope out the most ambitious possibilities short of full membership in the [European Union] or its common market, according to people familiar with the matter. The details are still being sketched by technical working groups for what the prime minister has told his aides will be the reorienting of an economy and a society that for half a century has been dominated by the U.S.”
ChatGPT generated this image of the European Parliament building in Brussels, Belgium.
Carney’s plan of shifting Canadian exports from the United States to the European Union (EU) faces obstacles similar to those faced by Bennett as he attempted to substitute markets in the United Kingdom for markets in the United States. As the following figures show, in 2025, more than 70 percent of Canadian exports of goods went to the United States, while less than 6 percent went to the EU. Similarly, about 45 percent of the Canadian imports of goods were from the United States, while less than 12 percent were from the EU.
It may well be that Carney’s negotiations with officials in the EU are an attempt to push the United States into agreeing to reduce tariffs on Canadian imports. As a practical matter, though, it seems unlikely that Canada can reorient its trading relationships from the United Sates to the EU to any significant degree.
8-22-26 Podcast – Glenn Hubbard & Tony O’Brien discuss higher long-term treasury yields and the challenges they present.
Join authors Glenn Hubbard & Tony O’Brien as they discuss rising long-term bond yields and their economic implications. Topics discussed include the federal government’s large budget deficit, concerns about fiscal credibility, and the Federal Reserve’s inability to meet its inflation target. The discussion also touched on the connection between federal budget deficits and trade imbalances, highlighting how large deficits require the U.S. to borrow from foreign investors.
Glenn’s Policy Advice to President Trump
Image of the White House generated by ChatGPT
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.
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.
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.
The United States Typically Runs Surpluses in Services as Well as Deficits in Goods
Image created by ChatGPT
A recent post on the blog of the Federal Reserve Bank of St. Louis reminds us that although the media and some policymakers tend to focus on the fact that the United States typically runs a deficit in trade in goods, it also typically runs a surplus in trade in services. We discuss these points in Economics, Chapter 9, Section 9.1 and Chapter 28, Section 28.1 (Macroeconomics, Chapter 7, Section 7.1 and Chapter 18, Section 18.1, and Microeconomics, Section 9.1). The first of the following figures shows U.S. net exports in services in dollar terms for the period from the first quarter of 1960 through the second quarter of 2025. The second figure show U.S. net exports in services as a percentage of U.S. GDP.
How does the United States compare to other countries? The following figure shows for 2024 the leaders in net exports of services for large economies (those with GDP of $1 trillion or more). The United States has largest value for net exports of services followed by the United Kingdom. China had negative net exports of services in 2024.
The following figure shows net exports in services as percentage of GDP among large economies. Measured this way, the largest net exporter of services is the United Kingdom, followed by Spain. The United States is included in graph (in red) for comparison and ranks ninth.
The following table from the St. Louis Fed’s blog posts shows the U.S. industries that export the most services.
The export of travel services represents largely foreign tourism in the United States. For example, if a family from France visits Walt Disney World in Florida, their spending would be included as an export of travel services.
October and November Jobs Data Give Mixed Picture of the Labor Market
Image created by ChatGPT
Because of the federal government shutdown from October 1 to November 12, the regular release by the Bureau of Labor Statistics (BLS) of its monthly “Employment Situation” report (often called the “jobs report”) has been disrupted. The jobs report usually 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.)
Today, the BLS released a jobs report that has data from the payroll survey for both October and November, but data from the household survey only for November. Because of the government shutdown, the household survey for October wasn’t conducted.
According to the establishment survey, there was a net decrease of 105,000 nonfarm jobs in October and a net increase of 64,000 nonfarm jobs in November. The increase for November was above the increase of 40,000 that economists surveyed by FactSet had forecast. Economists surveyed by the Wall Street Journal had forecast a net increase of 45,000 jobs. The BLS revised downward by a combined 33,000 jobs its previous estimates of employment in August and September. (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 illustrates that, as the BLS notes in the report, nonfarm payroll employment “has shown little net change since April.” The Trump administration announced sharp increases in U.S. tariffs on April 2. Media reports indicate that some firms have slowed hiring due to the effects of the tariffs or in anticipation of those effects. In addition, a sharp decline in immigration has slowed growth in the labor force.
The unemployment rate estimate relies on data collected in the household survey, so there id no unemployment estimate for October. As shown in the following figure, the unemployment rate increased from 4.4 percent in September to 4.6 percent in November, the highest rate since September 2021. The unemployment rate is above the 4.4 percent rate economists surveyed by FactSet had forecast. The unemployment rate had been remarkably stable, staying between 4.0 percent and 4.2 percent in each month from May 2024 to July 2025, before breaking out of that range in August. 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 now well above 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 increase of 96,000 jobs from September to November. In the payroll survey, there was a net decrease in of 41,000 jobs from September to November. In any particular month, the story told by the two surveys can be inconsistent. In this case, we are measuring the change in jobs over a two month interval because there is no estimate from the household survey of employment in October. Over that two month period the household survey is showing more strength in the labor market than is the payroll survey. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)
The household survey has another important labor market indicator: the employment-population ratio for prime age workers—those workers aged 25 to 54. In November the ratio was 80.6 percent, down slightly from 80.7 in September. (Again, there is no estimate for October.) The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is still above what the ratio was in any month during the period from January 2008 to February 2020. The continued high levels of the prime-age employment-population ratio indicates some continuing strength in the labor market.
The Trump Administration’s layoffs of some federal government workers are clearly shown in the estimate of total federal employment for October, when many federal government employees exhausted their severance pay. (The BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.”) As the following figure shows, there was a decline federal government employment of 162,000 in October, with an additional decline of 6,000 In November. The total decline since the beginning of February 2025 is 271,000. At this point, we can say that the decline in federal employment has had a significant effect on the overall labor market and may account for some of the rise in the unemployment rate.
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 3.5 percent in November, down from 3.7 percent in October.
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. In November, the 1-month rate of wage inflation was 1.6 percent, down from 5.4 percent in October. This slowdown in wage growth may be an indication of a weakening labor market. But one month’s data from such a volatile series may not accurately reflect longer-run trends in wage inflation.
What effect might today’s jobs report have on the decisions of the Federal Open Market Committee (FOMC) with respect to setting its target range for the federal funds rate? Today’s jobs report provides a mixed take on the state of the labor market with very slow job growth—although the large decline in federal employment is a confounding factor—a continued high employment-population ratio for prime age workers, and slowing wage growth.
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. (We discuss the futures market for federal funds in this blog post.) This morning, investors assigned a 75.6 percent probability to the committee leaving its target range unchanged at 3.50 percent to 3.75 percent at its next meeting on January 27–28. That probability is unchanged from the probability yesterday before the release of the jobs report. Investors apparently don’t see today’s report as providing much new information on the current state of the economy.
