The federal government’s fiscal year runs from October 1 to September 30. Today (October 8), the Congressional Budget Office (CBO) released its estimate of the deficit for the fiscal year ending September 30, 2025. The deficit fell slightly from $1,817 billion in 2024 to $1,809 in 2025. As the following figure shows, the budget deficit in 2025 remains very large, particularly at a time when the U.S. economy is at or very close to full employment, although well below the record deficit of $3,133 billion in 2020.
The following table from the CBO report shows that in 2025 federal receipts increased slightly more than federal outlays, leading to a slightly smaller deficit.
The next table shows the changes in the major categories of federal receipts. Individual income and payroll taxes—which fund the Social Security and Medicare programs, as well as the federal government’s contributions to state unemployment insurance plans—both increased, while corporate income tax receipts fell. The biggest change was in custom duties, which more than doubled following the Trump administration’s sharp increase in tariff rates beginning on April 2.
The next table shows the changes in the major categories of federal outlays. Spending on the Social Security, Medicare (health insurance for older people), and Medicaid (health insurance for lower-income people) programs continue to rapidly increase. Spending on Medicare is now more than $100 billion greater than spending on defense. Interest on the public debt continues to increase as the debt increases and interest rates remain well above their pre-2021 levels.
This morning (September 30), the federal government appears headed for a shutdown at midnight. As this handy explainer by David Wessel on the Brookings Institution website notes:
“… federal agencies cannot spend or obligate any money without an appropriation (or other approval) from Congress. When Congress fails to enact the 12 annual appropriation bills, federal agencies must cease all non-essential functions until Congress acts.
Government employees who provide what are deemed essential services, such as air traffic control and law enforcement, continue to work, but don’t get paid until Congress takes action to end the shutdown. All this applies only to the roughly 25% of federal spending subject to annual appropriation by Congress.”
A federal government shutdown can cause significant inconvenience to people who rely on nonessential government services. Federal government employees won’t receive paychecks nor will contractors supplying nonessential services, such as cleaning federal office buildings. Many federal government facilities, such as museums and national parks will be closed or will operate on reduced hours. It seems likely that the Bureau of Labor Statistics will not release on time its “Employment Situation Report” for September, which was due on Friday.
Apart from the effects just listed, how might a shutdown affect the broader economy? The most recent federal government shutdown occurred during the first Trump administration and lasted from December 22, 2018 to January 25, 2019. At the end of that shutdown, the Congressional Budget Office (CBO) prepared a report on its economic effects. The main conclusion of the report was that:
“In CBO’s estimation, the shutdown dampened economic activity mainly because of the loss of furloughed federal workers’ contribution to GDP, the delay in federal spending on goods and services, and the reduction in aggregate demand (which thereby dampened private-sector activity).”
Table 1 from the CBO report shows the effect of the shutdown on federal government expenditures. (Note that the CBO refers to the shutdown as being “partial” because, as in all federal government shutdowns, essential government services continued to be provided.)
Table 2 from the report shows the effects of the shutdown on real GDP.
Most of the macroeconomic effects of a government shutdown aren’t long lasting because most federal government spending that doesn’t occur during the shutdown is postponed rather than eliminated. When federal government employees return to work after the shutdown, they typically receive backpay for the time they were furloughed. The CBO estimates that the lasting effect of the shutdown on GDP was small “about $3 billion in forgone economic activity will not be recovered. That amount equals 0.02 percent of projected annual GDP in 2019.”
Will a federal government shutdown that begins at midnight tonight and lasts for a few weeks also have only a short-lived effect on the economy? That seems likely, although the Trump administration has indicated that if a shutdown occurs, some federal government employees will be fired rather than just furloughed. A significant reduction in federal employment could lead to a larger decrease in GDP that might persist for longer. The effect on the areas of Virginia and Maryland where most federal government workers live could be significant in the short run.
Modern industrial capitalism’s bounty has been breathtaking globally and especially in the U.S. It’s tempting, then, to look at critics in the crowd in Monty Python’s “Life of Brian” as they ask, “What have the Romans ever do for us?,” only to be confronted with a large list of contributions. But, in fact, over time, American capitalism has been saved by adapting to big economic changes.
We’re at another turning point, and the pattern of American capitalism’s keeping its innovative and disruptive core by responding, if sometimes slowly, to structural shocks will play out as follows.
The magnitude, scope and speed of technological change surrounding generative artificial intelligence will bring forth a new social insurance aimed at long-term, not just cyclical, impacts of disruption. For individuals, it will include support for work, community colleges and training, and wage insurance for older workers. For places, it will include block grants to communities and areas with high structural unemployment to stimulate new business and job opportunities. Such efforts are a needed departure from a focus on cyclical protection from short-term unemployment toward a longer-term bridge of reconnecting to a changing economy.
These ideas, like America’s historical big responses in land-grant colleges and the GI Bill, combine federal funding support with local approaches (allowing variation in responses to local business and employment opportunities), another hallmark of past U.S. economic policy.
With a stronger economic safety net, the current push toward higher tariffs and protectionism will gradually fade. Protectionism is a wall against change, but it is one that insulates us from progress, too.
A growing budget deficit and strains on public finances will lead to a reliance on consumption taxes to replace the current income tax system; continuing to raise taxes on saving and investment will arrest growth prospects. For instance, a tax on business cash flow, which places a levy on a firm’s revenue minus all expenses including investment, would replace taxes on business income. Domestic production would be enhanced by adding a border adjustment to business taxes—exports would be exempt from taxation, but companies can’t claim a deduction for the cost of imports.
That reform allows a shift from helter-skelter tariffs to tax reform that boosts investment and offers U.S. and foreign firms alike an incentive to invest in the U.S.
These ideas to retain opportunity amid creative destruction will also refresh American capitalism as the nation celebrates its 250th anniversary. They also celebrate the classical liberal ideas of Adam Smith, whose treatise “The Wealth of Nations” appeared the same year. This refresh marries competition’s role in “The Wealth of Nations” and American capitalism with the ability to compete, again a feature of turning points in capitalism in the U.S.
Decades down the road, this “Project 2026” will have preserved the bounty and mass prosperity of American capitalism.
These observations first appeared in the Wall Street Journal, along with predictions from six other economists and economic historians.
Today (September 26), the Bureau of Economic Analysis (BEA) released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report. Yesterday, the BEA released its revised estimate of real GDP growth in the second quarter. Taken together, the two reports show that economic growth remains realtively strong and that inflation continues to run above the Fed’s 2 percent annual target.
Taking the inflation report first, 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 2018, with inflation measured as the percentage change in the PCE from the same month in the previous year. In August, headline PCE inflation was 2.7 percent, up from 2.6 percent in July. Core PCE inflation in August was 2.9 percent, unchanged from July. Headline PCE inflation was equal to the forecast of economists surveyed, while core PCE inflation was slightly lower than forecast.
The following figure shows headline PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, headline PCE inflation increased from 2.0 percent in July to 3.2 percent in August. Core PCE inflation declined slightly from 2.9 percent in July to 2.8 percent in August. So, both 1-month and 12-month PCE inflation are telling the same story of inflation being well above the Fed’s target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure). In addition, these data likely reflect higher prices resulting from the tariff increases the Trump administration has implemented. Once the one-time price increases from tariffs have worked through the economy, inflation may decline. It’s not clear, however, how long that may take and President Trump indicated yesterday that he may impose new tariffs on pharmaceuticals, large trucks, and furniture.
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 fall, the prices of financial services included in the PCE price index also fall. 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 2.4 percent in August, unchanged from July. Core market-based PCE inflation was 2.6 percent in August, also unchanged from July. So, both market-based measures show inflation as stable but above the Fed’s 2 percent target.
In the following figure, we look at 1-month inflation using these measures. One-month headline market-based inflation increase sharply to 2.5 percent in August from 0.9 percent in July. One-month core market-based inflation increased slightly to 1.9 percent in August from 1.8 percent in July. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate.
Inflation running above the Fed’s 2 percent target is consistent with relatively strong growth in real GDP. The following figure shows compound annual rates of growth of real GDP, for each quarter since the first quarter of 2023. The value for the second quarter of 2025 is the BEA’s third estimate. This revised estimate increased the growth rate of real GDP to 3.8 percent from the second estimate of 3.3 percent.
The most important contributor to real GDP growth was growth in real personal consumption expenditures, which, as shown in the following figure, increased aat compound annual rate of 2.5 percent in the second quarter, up from 0.6 percent in the first quarter.
High interest rates continue to hold back residential construction, which declined by a compound annual rate of 5.1 percent in the second quarter after declining 1.0 percent in the first quarter.
Business investment in structures, such as factories and office buildings, continued a decline that began in the first quarter of 2024.
Will the relatively strong growth in real GDP in the second quarter continue in the third quarter? Economists at the Federal Reserve Bank of Atlanta prepare nowcasts of real GDP. A nowcast is a forecast that incorporates all the information available on a certain date about the components of spending that are included in GDP. The Atlanta Fed calls its nowcast GDPNow. As the following figure from the Atlanta Fed website shows, today the GDPNow forecast is for real GDP to grow at an annual rate of 3.9 percent in the third quarter.
Finally, the macroeconomic data released in the last two days has had realtively little effect on the expectations of investors trading federal funds rate futures. Investors assign an 89.8 percent probability to the Federal Open Market Committee (FOMC) cutting its target for the federal funds rate at its meeting on October 28–29 by 0.25 percentage point (25 basis points) from its current range of 4.00 percent to 4.25 percent. That probability is only slightly lower than 91.9 percent probaiblity that investors had assigned to a 25 basis point cut a week ago. However, the probability of the committee cutting its target rate by another 25 basis points at its December 9–10 fell to 67.0 percent today from 78.6 percent one week ago.
Supports:Macroeconomics, Chapter 13, Section 13.3; Economics, Chapter 23, Section 23.3; and Essentials of Economics, Chapter 15, Section 15.3
Image generated by ChatGPT
A recent article on axios.com made the following observation: “The mainstream view on the Federal Open Market Committee is based on risk management—that the possibility of a further downshift in the job market appears to be the more pressing concern than the chance that inflation will spiral higher.” The article also notes that: “Tariffs’ effects on inflation are probably a one-time bump.”
a. What is the dual mandate that Congress has given the Federal Reserve?
b. In what circumstances might the Federal Open Market Committee (FOMC) be faced with a conflict between the goals in the dual mandate?
c. What does the author mean by tariffs’ effects on inflation being a “one-time bump”?
d. What does the author mean by the FOMC engaging in “risk management”? What is a “downshift” in the labor market? If the FOMC is more concerned about a downshift in the labor market than about inflation, will the committee raise or lower its target for the federal funds rate? Briefly explain.
Solving the Problem Step 1: Review the chapter material. This problem is about the policy dilemma the Fed can face when the unemployment rate and the inflation rate are both rising, so you may want to review Macroeconomics, Chapter 13, Section 13.3, “Macroeconomic Equilibrium in the Long Run and the Short Run.”
Step 2: Answer part a. by explaining what the Fed’s dual mandate is. Congress has given the Fed a dual mandate of achieving price stability and maximum employment.
Step 3: Answer part b. by explaining when the FOMC may face a conflict with respect to its dual mandate. When the FOMC is faced with rising unemployment and falling inflation, its preferred policy response is clear: The committee will lower its target for the federal funds rate in order to increase the growth of aggregate demand, which will increase real GDP and reduce unemployment. When the FOMC is faced with falling unemployment and rising inflation, its preferred policy response is also clear: The committee will raise its target for the federal funds rate in order to slow the growth of aggregate demand, which will reduce the inflation rate.
But when the Fed faces an aggregate supply shock, its preferred policy response is unclear. An aggregate supply shock, such as the U.S. economy experienced during the Covid pandemic and again with the tariff increases that the Trump administration began implementing in April, will shift the short-run aggregate supply curve (SRAS) will shift to the left, causing an increase in the price level, along with a decline in real GDP and employment. This combination of rising unemployment and inflation is called stagflation. In this situation, the FOMC faces a policy dilemma: Raising the target for the federal funds rate will help reduce inflation, but will likely increase unemployment, while lowering the target for the federal funds rate will lead to lower unemployment, but will likely increase inflation. The following figure shows the situation during the Covid pandemic when the economy experienced both an aggregate demand and aggregate supply shock. The aggregate demand curve and the aggregate supply curve both shifted to the left, resulting in falling real GDP (and employment) and a rising price level.
Step 4: Answer part c. by explaining what it means to refer to the effect of tariffs on inflation being a “one-time bump.” Tariffs cause the aggregate supply curve to shift to the left because by increasing the prices of raw materials and other inputs, they increase the production costs of some businesses. Assuming that tariffs are not continually increasing, their effect on the price level will end once the production costs of firms stop rising.
Step 5: Answer part d. by explaining what the author means by the FOMC engaing in “risk management,” explaining what a “downshift” in the labor is, and whether if the FOMC is more concerned about a downshift in the labor market than in inflation, it will raise or lower its target for the federal funds rate. The article refers to the “possibility” of a further downshift in the labor market. A downshift in the labor market means that the demand for labor may decline, raising the unemployment rate. Managing the risk of this possibility would involve concentrating on the maximum employment part of the Fed’s dual mandate by lowering its target for the federal funds rate. Note that the expectation that the effect of tariffs on the price level is a one-time bump makes it easier for the committee to focus on the maximum employment part of its mandate because the increase in inflation due to the tariff increases won’t persist.
Photo of Fed Chair Jerome Powell from federalreserve.gov
Today’s meeting of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) occurred against a backdrop of President Trump pressuring the committee to reduce its target for the federal funds rate. In a controversial move, Trump nominated Stephen Miran, chair of Council of Economic Advisers (CEA), to fill an open seat on the Fed’s Board of Governors. Miran took a leave of absence from the CEA rather than resign his position, which made him the first member of the Board of Governors in decades to maintain an appointment elsewhere in the executive branch while serving on the Board. In addition, Trump had fired Governor Lisa Cook on the grounds that she had committed fraud in applying for a mortgage at a time before her appointment to the Board. Cook denied the charge and a federal appeals court sustained an injunction allowing her to participate in today’s meeting.
As most observers had expected, the committee decided today to lower its target for the federal funds rate from a range of 4.25 percent to 4.50 percent to a range of 4.00 percent to 4.25 percent—a cut of 0.25 percentage point, or 25 basis points. The members of the committee voted 11 to 1 for the 25 basis point cut with Miran dissenting because he preferred a 50 basis point cut.
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 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 in its target range in Macroeconomics, Chapter 15, Section 15.2 (Economics, Chapter 25, Section 25.2).)
After the meeting, the committee also released a “Summary of Economic Projections” (SEP)—as it typically does after its March, June, September, and December meetings. The SEP presents median values of the 19 committee members’ forecasts of key economic variables. The values are summarized in the following table, reproduced from the release. (Note that only 5 of the district bank presidents vote at FOMC meetings, although all 12 presidents participate in the discussions and prepare forecasts for the SEP.)
There are several aspects of these forecasts worth noting:
Committee members slightly increased their forecasts of real GDP growth for each year from 2025 through 2027. Committee members also slightly decreased their forecasts of the unemployment rate in 2026 and 2027. They left their forecast of unemployment in the fourth quarter of 2025 unchanged at 4.5 percent. (The unemployment rate in August was 4.3 percent.)
Committee members left their forecasts for personal consumption expenditures (PCE) price inflation unchanged for 2025 and 2026, while raising their forecast for 2026 from 2.4 percent to 2.6 percent. Similarly, their forecasts of core PCE inflation were unchanged for 2025 and 2027 but increased from 2.4 percent to 2.6 percent for 2026. The committee does not expect that PCE inflation will decline to the Fed’s 2 percent annual target until 2028.
The committee’s forecast of the federal funds rate at the end of 2025 was lowered from 3.9 percent in June to 3.6 percent today. They also lowered their forecast for federal funds rate at the end of 2026 from 3.6 percent to 3.4 pecent and at the end of 2027 from 3.4 percent to 3.1 percent.
Prior to the meeting there was much discussion in the business press and among investment analysts about the dot plot, shown below. Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 19 dots, representing the 7 members of the Fed’s Board of Governors and all 12 presidents of the Fed’s district banks.
The plots on the far left of the figure represent the projections of each of the 19 members of the value of the federal funds rate at the end of 2025. Ten of the 19 members expect that the committee will cut its target range for the federal funds rate by at least 50 basis points in its two remaining meetings this year. That narrow majority makes it likely that an unexpected surge in inflation during the next few months might result in the target range being cut by only 25 basis points or not cut at all. Members of the business press and financial analysts are expecting tht the committee will implement a 25 basis point cut in each of its last two meetings this year.
During his press conference following the meeting, Powell indicated that the recent increase in inflation was largely due to the effects of the increase in tariff rates that the Trump administration began implementing in April. (We discuss the recent data on inflation in this post.) Powell indicated that committee members expect that the tariff increases will cause a one-time increase in the price level, rather than causing a long-term increase in the inflation rate. Powell also noted recent slow growth in real GDP and employment. (We discuss the recent employment data in this blog post.) As a result, he said that the shift in the “balance of risks” caused the committee to believe that cutting the target for the federal funds rate was warranted to avoid the possibility of a significant rise in the unemployment rate.
The next FOMC meeting is on October 28–29 by which time the status of Lisa Cook on the committee may have been clarified. It also seems likely that President Trump will have named the person he intends to nominate to succeed Powell as Fed chair when Powell’s term ends on May 15, 2026. (Powel’s term on the Board doesn’t end until January 31, 2028, although Fed chairs typically resign from the Board if they aren’t reappointed as chair). And, of course, additional data on inflation and unemployment will also have been released.
Today (September 11), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for August. 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 2.9 percent in August, up from 2.7 in July.
The core inflation rate,which excludes the prices of food and energy, was 3.1 percent in August, up slightly from 3.0 percent in July.
Headline inflation and core inflation were both the same as 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) jumped from 2.4 percent in July to 4.7 percent in August. Core inflation (the red line) increased from 3.9 percent in July to 4.2 percent in August.
The 1-month and 12-month inflation rates are both indicating that inflation accelerated in August. Core inflation—which is often a good indicator of future inflation—in particular has been running well above the Fed’s 2 percent inflation target during the last two months.
Of course, it’s important not to overinterpret the data from a single month. The figure shows that the 1-month inflation rate is particularly volatile. Also 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.
Core inflation had been running significantly higher than headline inflation in the past few months because gasoline prices had generally been falling since February. Gasoline prices turned around in August, however, increasing at a 25.5 percent annual rate. As shown in the following figure, 1-month inflation in gasoline prices moves erratically—which is the main reason that gasoline prices aren’t included in core inflation.
Does the increase in inflation represent the effects of the increases in tariffs that the Trump administration announced on April 2? (Note that many of the tariff increases announced on April 2 have since been reduced) The following figure shows 12-month inflation in durable goods—such as furniture, appliances, and cars—which are likely to be affected directly by tariffs, and services, which are less likely to be affected by tariffs.. To make recent changes clearer, we look only at the months since January 2022. In August, inflation in durable goods increased to 1.9 percent from 1.2 percent in July. Inflation in services in August was 3.8 percent, unchanged from July.
The following figure shows 1-month inflation in the prices of these products, which may make the effects of tariffs clearer. In August, durable goods inflation was 5.1 percent up from 4.5 percent in July. Service inflation was 3.9 percent in August, down slightly from 4.0 percent in July. Inflation in goods and services both running well above 2 percent is not good news for inflation falling back to the Fed’s 2 percent target in the near future.
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 3.3 percent in August, up slightly from 3.2 July. Twelve-month median inflation (the red line) 3.6 percent in August, unchanged from July.
The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation rose from 2.9 percent in July to 3.2 percent in August. One-month median inflation remained unchanged at 3.4 percent in August. These data are consistent with the view that inflation is running above the Fed’s 2 percent target.
The CPI inflation data combined with the recent jobs data (which we discuss here and here), indicate that the U.S. economy may be entering a period of stagflation—a combination of rising inflation with falling, or stagnating, output. Stagflation poses a policy dilemma for the Fed’s policymaking Federal Open Market Committee (FOMC) because cutting its target for the federal funds rate to increase economic growth and employment may worsen inflation. At this point, it seems likely that the FOMC will “look through” this month’s rising inflation because it may be largely due to one-time price increases caused by tariffs. Committee members have signaled that they are likely to cut their target for the federal funds rate by 0.25 percent (25 basis points) at the conclusion of their meeting on September 16–17 and again at the conclusion of the following meeting on October 28–29.
Today (September 9), the Bureau of Labor Statistics (BLS) issued revised estimates of the increase in employment, as measured by the establishment survey, over the period from April 2024 through March 2025. The BLS had initially estimated that during that period net employment had increased by a total of 1,758,000 or an average of 147,000 jobs per month. The revision lowered this estimate by more than half to a total of 839,000 jobs or an average of only 70,000 net new jobs created per month. The difference between those two monthly averages means that the U.S. economy had generated a total of 919,000 fewer jobs during that period. The revision was larger than the downward revision of 800,000 jobs forecast by economists at Wells Fargo, Comerica Bank, and Pantheon Macroeconomics.
Why does the BLS have to revise its employment estimates? As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1) the initial estimates that the BLS issues each month in its “Employment Situation” reports are based on a sample of 121,000 businesses and government agencies representing 631,000 worksites or “establishments.” The monthly data also rely on estimates of the number of employees at establishments that opened or closed during the month and on employment changes at establishments that failed to respond to the survey. In August or September of each year, the BLS issues revised employment estimates based on data from the Quarterly Census of Employment and Wages (QCEW), which relies on state unemployment insurance tax records. The unemployment tax records are much more comprehensive than the original sample of establishments because nearly all employers are included.
In today’s report, the BLS cited two likely sources of error in their preliminary estimates:
“First, businesses reported less employment to the QCEW than they reported to the CES survey (response error). Second, businesses who were selected for the CES survey but did not respond reported less employment to the QCEW than those businesses who did respond to the CES survey (nonresponse error).”
The preliminary benchmark estimates the BLS released today will be revised again and the final estimates for these months will be released in February 2026. The difference between the preliminary and final benchmark estimates can be substantial. For example, last year, the BLS’s initially preliminary benchmark estimate indicated that the net employment increase from April 2023 to March 2024 had been overestimated by 818,000 jobs. In February 2025, the final benchmark estimate reduced this number to 598,000 jobs.
Although this year’s revision is particularly large in absolute terms—the largest since at least 2001—it still represents only about 0.56 percent of the more than 159.5 million people employed in the U.S. economy. Still the size of this revision is likely to increase political criticism of the BLS.
How will this revision affect the decision by the Federal Open Market Committee (FOMC) at its next meeting on September 16-17 to cut or maintain its target for the federal funds rate? The members of the committee were probably not surprised by the downward revision in the employment estimates, although they may have anticipated that the revision would be smaller. In six of the past seven years, the BLS has revised its estimates of payroll employment downward in its annual preliminary benchmark revision.
As we noted in this recent post, even before the BLS revised its employment estimates downward, recent monthly net employment increases were well below the increases during the first half of the year. There was already a high likelihood that the FOMC intended to cut its target for the federal funds rate at its meeting on September 16–17. The substantial downward revision in the employment data makes a cut at the September meeting nearly a certainty and increases the likelihood that the FOMC will implement a second cut in its target for the federal funds rate at the committee’s meeting on October 28–29.
Image generated by ChatGPT 5 of a 1981 IBM personal computer.
The modern era of information technology began in the 1980s with the spread of personal computers. A key development was the introduction of the IBM personal computer in 1981. The Apple II, designed by Steve Jobs and Steve Wozniak and introduced in 1977, was the first widely used personal computer, but the IBM personal computer had several advantages over the Apple II. For decades, IBM had been the dominant firm in information technology worldwide. The IBM System/360, introduced in 1964, was by far the most successful mainframe computer in the world. Many large U.S. firms depended on IBM to meet their needs for processing payroll, general accounting services, managing inventories, and billing.
Because these firms were often reliant on IBM for installing, maintaining, and servicing their computers, they were reluctant to shift to performing key tasks with personal computers like the Apple II. This reluctance was reinforced by the fact that few managers were familiar with Apple or other early personal computer firms like Commodore or Tandy, which sold the TRS-80 through Radio Shack stores. In addition, many firms lacked the technical staffs to install, maintain, and repair personal computers. Initially, it was easier for firms to rely on IBM to perform these tasks, just as they had long been performing the same tasks for firms’ mainframe computers.
By 1983, the IBM PC had overtaken the Apple II as the best-selling personal computer in the United States. In addition, IBM had decided to rely on other firms to supply its computer chips (Intel) and operating system (Microsoft) rather than develop its own proprietary computer chips and operating system. This so-called open architecture made it possible for other firms, such as Dell and Gateway, to produce personal computers that were similar to IBM’s. The result was to give an incentive for firms to produce software that would run on both the IBM PC and the “clones” produced by other firms, rather than produce software for Apple personal computers. Key software such as the spreadsheet program Lotus 1-2-3 and word processing programs, such as WordPerfect, cemented the dominance of the IBM PC and the IBM clones over Apple, which was largely shut out of the market for business computers.
As personal computers began to be widely used in business, there was a general expectation among economists and policymakers that business productivity would increase. Productivity, measured as output per hour of work, had grown at a fairly rapid average annual rate of 2.8 percent between 1948 and 1972. As we discuss in Macroeconomics, Chapter 10 (Economics, Chapter 20 and Essentials of Economics, Chapter 14) rising productivity is the key to an economy achieving a rising standard of living. Unless output per hour worked increases over time, consumption per person will stagnate. An annual growth rate of 2.8 percent will lead to noticeable increases in the standard of living.
Economists and policymakers were concerned when productivity growth slowed beginning in 1973. From 1973 to 198o, productivity grew at an annual rate of only 1.3 percent—less than half the growth rate from 1948 to 1972. Despite the widespread adoption of personal computers by businesses, during the 1980s, the growth rate of productivity increased only to 1.5 percent. In 1987, Nobel laureate Robert Solow of MIT famously remarked: “You can see the computer age everywhere but in the productivity statistics.” Economists labeled Solow’s observation the “productivity paradox.” With hindsight, it’s now clear that it takes time for businesses to adapt to a new technology, such as personal computers. In addition, the development of the internet, increases in the computing power of personal computers, and the introduction of innovative software were necessary before a significant increase in productivity growth rates occurred in the mid-1990s.
Result when ChatGPT 5 is asked to create an image illustrating ChatGPT
The release of ChatGPT in November 2022 is likely to be seen in the future as at least as important an event in the evolution of information technology as the introduction of the IBM PC in August 1981. Just as with personal computers, many people have been predicting that generative AI programs will have a substantial effect on the labor market and on productivity.
In this recent blog post, we discussed the conflicting evidence as to whether generative AI has been eliminating jobs in some occupations, such as software coding. Has AI had an effect on productivity growth? The following figure shows the rate of productivity growth in each quarter since the fourth quarter of 2022. The figure shows an acceleration in productivity growth beginning in the fourth quarter of 2023. From the fourth quarter of 2023 through the fourth quarter of 2024, productivity grew at an annual rate of 3.1 percent—higher than during the period from 1948 to 1972. Some commentators attributed this surge in productivity to the effects of AI.
However, the increase in productivity growth wasn’t sustained, with the growth rate in the first half of 2025 being only 1.3 percent. That slowdown makes it more likely that the surge in productivity growth was attributable to the recovery from the 2020 Covid recession or was simply an example of the wide fluctuations that can occur in productivity growth. The following figure, showing the entire period since 1948, illustrates how volatile quarterly rates of productivity growth are.
How large an effect will AI ultimately have on the labor market? If many current jobs are replaced by AI is it likely that the unemployment rate will soar? That’s a prediction that has often been made in the media. For instance, Dario Amodei, the CEO of generative AI firm Anthropic, predicted during an interview on CNN that AI will wipe out half of all entry level jobs in the U.S. and cause the unemployment rate to rise to between 10% and 20%.
Although Amodei is likely correct that AI will wipe out many existing jobs, it’s unlikely that the result will be a large increase in the unemployment rate. As we discuss in Macroeconomics, Chapter 9 (Economics, Chapter 19 and Essentials of Economics, Chapter 13) the U.S. economy creates and destroys millions of jobs every year. Consider, for instance, the following table from the most recent “Job Openings and Labor Turnover” (JOLTS) report from the Bureau of Labor Statistics (BLS). In June 2025, 5.2 million people were hired and 5.1 million left (were “separated” from) their jobs as a result of quitting, being laid off, or being fired.
Most economists believe that one of the strengths of the U.S. economy is the flexibility of the U.S. labor market. With a few exceptions, “employment at will” holds in every state, which means that a business can lay off or fire a worker without having to provide a cause. Unionization rates are also lower in the United States than in many other countries. U.S. workers have less job security than in many other countries, but—crucially—U.S. firms are more willing to hire workers because they can more easily lay them off or fire them if they need to. (We discuss the greater flexibility of U.S. labor markets in Macroeconomics, Chapter 11 (Economics, Chapter 21).)
The flexibility of the U.S. labor market means that it has shrugged off many waves of technological change. AI will have a substantial effect on the economy and on the mix of jobs available. But will the effect be greater than that of electrification in the late nineteenth century or the effect of the automobile in the early twentieth century or the effect of the internet and personal computing in the 1980s and 1990s? The introduction of automobiles wiped out jobs in the horse-drawn vehicle industry, just as the internet has wiped out jobs in brick-and-mortar retailing. People unemployed by technology find other jobs; sometimes the jobs are better than the ones they had and sometimes the jobs are worse. But economic historians have shown that technological change has never caused a spike in the U.S. unemployment rate. It seems likely—but not certain!—that the same will be true of the effects of the AI revolution.
Which jobs will AI destroy and which new jobs will it create? Except in a rough sense, the truth is that it is very difficult to tell. Attempts to forecast technological change have a dismal history. To take one of many examples, in 1998, Paul Krugman, later to win the Nobel Prize, cast doubt on the importance of the internet: “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.” Krugman, Amodei and other prognosticators of the effects of technological change simply lack the knowledge to make an informed prediction because the required knowledge is spread across millions of people.
That knowledge only becomes available over time. The actions of consumers and firms interacting in markets mobilize information that is initially known only partially to any one person. In 1945, Friedrich Hayek made this argument in “The Use of Knowledge in Society,” which is one of the most influential economics articles ever written. One of Hayek’s examples is an unexpected decrease in the supply of tin. How will this development affect the economy? We find out only by observing how people adapt to a rising price of tin: “The marvel is that … without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation are made [by the increase in the price of tin] to use the material or its products more sparingly.” People adjust to changing conditions in ways that we lack sufficient information to reliably forecast. (We discuss Hayek’s view of how the market system mobilizes the knowledge of workers, consumers, and firms in Microeconomics, Chapter 2.)
It’s up to millions of engineers, workers, and managers across the economy, often through trial and error, to discover how AI can best reduce the cost of producing goods and services or improve their quality. Competition among firms drives them to make the best use of AI. In the end, AI may result in more people or fewer people being employed in any particular occupation. At this point, there is no way to know.
On August 29, the Bureau of Economic Analysis (BEA) released data for July on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report. 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 2017, with inflation measured as the percentage change in the PCE from the same month in the previous year. In July, headline PCE inflation was 2.6 percent, unchanged from June. Core PCE inflation in July was 2.9 percent, up slightly from 2.8 percent in June. Headline PCE inflation and core PCE inflation were both equal to what economists surveyed had forecast.
The following figure shows headline PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, headline PCE inflation fell from 3.5 percent in June to 2.4 percent in July. Core PCE inflation increased slightly from 3.2 percent in June to 3.3 percent in July. So, both 1-month PCE inflation estimates are above the Fed’s 2 percent target, with 1-month core PCE inflation being well above target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so we shouldn’t attempt to draw wider conclusions from one month’s data. In addition, these data may reflect higher prices resulting from the tariff increases the Trump administration has implemented. Once the one-time price increases from tariffs have worked through the economy, inflation may decline. It’s not clear, however, how long that may take and it’s likely that not all the effects of the tariff increases on the price level are reflected in this month’s data.
As usual, we need to note that 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 fall, the prices of financial services included in the PCE price index also fall. 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 2.3 percent in July, unchanged from June. Core market-based PCE inflation was 2.6 percent in July, also unchanged from June. So, both market-based measures show inflation as stable but above the Fed’s 2 percent target.
In the following figure, we look at 1-month inflation using these measures. One-month headline market-based inflation declined sharply to 1.1 percent in July from 4.1 percent in June. One-month core market-based inflation also declined sharply to 2.1 percent in July from 3.8 percent in June. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate. Still, looking at 1-month inflation gives us a better look at current trends in inflation, which these data indicate is slowing significantly.
As we noted earlier, some of the increase in inflation is likely attributable to the effects of tariffs. The effect of tariffs are typically seen in goods prices, rather than in service prices because tariffs are levied primarily on imports of goods. As the following figure shows, one-month inflation in goods prices jumped in June to 4.8 percent, but then declined sharply to –1.6 in July. One-month inflation in services prices increased from 2.9 percent in June to 4.3 percent in July. Clearly, the 1-month inflation data—particularly for goods—are quite volatile.
Finally, these data had little effect on the expectations of investors trading federal funds rate futures. Investors assign an 86.4 percent probability to the Federal Open Market Committee (FOMC) cutting its target for the federal funds rate at its meeting on September 16–17 by 0.25 percentage point (25 basis points) from its current range of 4.25 percent to 4.5o percent. There has been some speculation in the business press that the FOMC might cut its target by 50 basis points at that meeting, but with inflation remaining above target, investors don’t foresee a larger cut in the target range happening.
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