Money. Banking, and the Financial System – Page 3 – HubbardOBrienEconomics.com Blog

Glenn’s Questions for the Fed

Photo from federalreserve.gov

This opinion column originally ran at Project Syndicate.

While recent media coverage of the US Federal Reserve has tended to focus on when, and by how much, interest rates will be cut, larger issues loom. The selection of a new Fed chair to succeed Jerome Powell, whose term ends next May, should focus not on short-term market considerations, but on policies and processes that could improve the Fed’s overall performance and accountability.

By demanding that the Fed cut the federal funds rate sharply to boost economic activity and lower the government’s borrowing costs, US President Donald Trump risks pushing the central bank toward an overly inflationary monetary policy. And that, in turn, risks increasing the term premium in the ten-year Treasury yield—the very financial indicator that Treasury Secretary Scott Bessent has emphasized. A higher premium would raise, not lower, borrowing costs for the federal government, households, and businesses alike. Moreover, concerns about the Fed’s independence in setting monetary policy could undermine confidence in US financial markets and further weaken the dollar’s exchange rate.

But this does not imply that Trump should simply seek continuity at the Fed. The Fed, under Powell, has indeed made mistakes, leading to higher inflation, sometimes inept and uncoordinated communications, and an unclear strategy for monetary policy.

I do not share the opinion of Trump and his advisers that the Fed has acted from political or partisan motives. Even when I have disagreed with Fed officials or Powell on matters of policy, I have not doubted their integrity. However, given their mistakes, I do believe that some institutional introspection is warranted. The next chair—along with the Board of Governors and the Federal Open Market Committee—will have many policy questions to address beyond the near-term path for the federal funds rate.

Three issues are particularly important. The first is the Fed’s dual mandate: to ensure stable prices and maximum employment. Many economists (including me) have been critical of the Fed for exhibiting an inflationary bias in 2021 and 2022. The highest inflation rate in 40 years raised pressing questions about whether the Fed has assigned the right weights to inflation and employment.

Clearly, the strategy of pursuing a flexible average inflation target (implying that inflation can be permitted to rise above 2% if it had previously been below 2%) has not been successful. What new approach should the Fed adopt to hit its inflation target? And how can the Fed be held more accountable to Congress and the public? Should it issue a regular inflation report?

The second issue concerns the size and composition of the Fed’s balance sheet. Since the global financial crisis of 2008, the Fed has had a much larger balance sheet and has evolved toward an “ample reserves model” (implying a perpetually high level of reserves). But how large must the balance sheet be to conduct monetary policy, and how important should long-term Treasury debt and mortgage-backed securities be, relative to the rest of the balance sheet? If such assets are to play a central role, how can the Fed best separate the conduct of monetary policy from that of fiscal policy?

The third issue is financial regulation. What regulatory changes does the Fed believe are needed to avoid the kind of costly stresses in the Treasury market we have witnessed in recent years? How can bank supervision be improved? Given that regulation is an inherently political subject, how can the Fed best separate these activities from its monetary policymaking (where independence is critical)?

Addressing these policy questions requires a rethink of process, too. The Fed would be more effective in dealing with a changing economic environment if it acknowledged and debated more diverse viewpoints about the roles of monetary policy and financial regulation in how the economy works.

The Fed’s inflation mistakes, overconfidence in financial regulation, and other errors partly reflect the “groupthink” to which all organizations are prone. Regional Fed presidents’ views traditionally have reflected their own backgrounds and local conditions, but that doesn’t translate easily into a diversity of economic views. Instead of choosing Fed officials based on how they are likely to vote at the next rate-setting meeting, Trump should put more weight on intellectual and experiential diversity. Equally, the Fed itself could more actively seek and listen to dissenting views from academic and business leaders.

Raising questions about policy and process offers guidance about the characteristics that the next Fed chair will need to succeed. These obviously include knowledge of monetary policy and financial regulation and mature, independent judgment; but they also include diverse leadership experience and an openness to new ideas and perspectives that might enhance the institution’s performance and accountability. One hopes that Trump’s selection of the next Fed chair, and the Senate’s confirmation process, will emphasize these attributes.

CPI Inflation Comes in Slightly Below Expectations, Increasing Likelihood of Fed Rate Cuts

Fed Chair Jerome Powell (left) and Vice Chair Philip Jefferson (photo from federalreserve.gov)

Today (August 12), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for July. 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 2.7 percent in July, unchanged from June.
The core inflation rate, which excludes the prices of food and energy, was 3.0 percent in July, up slightly from 2.9 percent in June. (Note that there was some inconsistency in how the core inflation rate is reported. The BLS, and some news outlets, give the value as 3.1 percent. The unrounded value is 3.0486 percent.)

Headline inflation and core inflation were slightly lower than what economists surveyed had expected.

In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) declined from 3.5 percent in June to 2.4 percent in July. Core inflation (the red line) increased from 2.8 percent in June to 3.9 percent in July.

The 1-month and 12-month inflation rates are telling somewhat different stories, with 12-month inflation indicating that inflation is stable, although moderately above the Fed’s 2 percent inflation target. The 1-month core inflation rate indicates that inflation may have increased during July.

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.

A key reason for core inflation being significantly higher than headline inflation is that gasoline prices declined by 23.1 percent at an annual rate in June. 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 three categories of products whose prices are thought to be particularly vulnerable to the effects of tariffs: apparel (the blue line), toys (the red line), and motor vehicles (the green line). To make recent changes clearer, we look only at the months since January 2021. In July, prices of apparel fell, while the prices of toys and motor vehicles rose by less than 1.0 percent.

The following figure shows 1-month inflation in these prices of these products. In July, motor vehicles prices and apparel prices increased by less than 1 percent, while toy prices increased by 1.9 percent after having soared soared by 24.3 percent in June. At least for these three products, it’s difficult to see tariffs as having had a significant effect on inflation in July.

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 3.2 percent in July, unchanged from June. Twelve-month median inflation (the red line) 3.6 percent in July, unchanged from June.

The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation declined from 3.9 percent in June to 2.9 percent in July. One-month median inflation also declined from 4.1 percent in June to 3.7 percent in July. These data indicate that inflation may have slowed in July (the opposite conclusion we noted earlier when discussing 1-month core inflation), while remaining above the Fed’s 2 percent target.

What are the implications of this CPI report for the actions the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) may take at its next meetings? Even before today’s relatively favorable, if mixed, inflation report, the unexpectedly weak jobs report at the beginning of the month (which we discuss in this blog post) made it likely that the FOMC would soon begin cutting its target for the federal funds rate.

Investors who buy and sell federal funds futures contracts assign a probability of 94.3 percent to FOMC cutting its target for the federal funds rate at its September 16–17 meeting by 0.25 (25 basis points) from its current target range of 4.25 percent to 4.50 percent. That probability increased from 85.9 percent yesterday. (We discuss the futures market for federal funds in this blog post.) Investors assign a probability of 61.5 percent to the FOMC cutting its target again by 25 basis points at its October 28–29 meeting, and a probability of 50.3 percent to a third 25 basis point cut at the committee’s December 9–10 meeting.

Before There was Inexpensive Computing …

… there were artists in government agencies drawing time series graphs. As we discuss in this recent blog post, the Bureau of Labor Statistics (BLS) has been in the news lately—undoubtedly much more than the people who work there would like.

This post is not about the current controversy but steps back to make a bigger point: The availability of data has increased tremendously from the time when Glenn and Tony began their academic careers. In the 1980s, personal computers were becoming widespread, but the internet had not yet developed to the point where government statistics were available to download. To gather data usually required a trip to the university library to make photocopies of tables in the print publications of the BLS and other government agencies. You then had to enter the data by hand into very crude—by current standards—spreadsheet and statistical software. The software generally had limited graphing capabilities.

How were the time series figures in print government publications generated? The two photos shown above (both from the website of the Library of Congress) show that the figures were hand drawn by artists. The upper photo is from 1962 and the lower photo is from 1971.

Today, most government data is readily available online. The FRED (Federal Reserve Economic Data) site, hosted by economists at the Federal Reserve Bank of St. Louis makes available thousands of data series. We make use of these series in the Data Exercises included in the end-of-chapter problems in our textbooks. The FRED site makes it easy (we hope!) to do these exercises, including by combining or otherwise transforming data series and by graphing them—no artistic ability required!

H/T

Why Were the Data Revisions to Payroll Employment in May and June So Large?

Image generated by ChatTP-4o

As we noted in yesterday’s blog post, the latest “Employment Situation” report from the Bureau of Labor Statistics (BLS) included very substantial downward revisions of the preliminary estimates of net employment increases for May and June. The previous estimates of net employment increases in these months were reduced by a combined 258,000 jobs. As a result, the BLS now estimates that employment increases for May and June totaled only 33,000, rather than the initially reported 291,000. According to Ernie Tedeschi, director of economics at the Budget Lab at Yale University, apart from April 2020, these were the largest downward revisions since at least 1979.

The size of the revisions combined with the estimate of an unexpectedly low net increase of only 73,000 jobs in June prompted President Donald Trump to take the unprecedented step of firing BLS Commissioner Erika McEntarfer. It’s worth noting that the BLS employment estimates are prepared by professional statisticians and economists and are presented to the commissioner only after they have been finalized. There is no evidence that political bias affects the employment estimates or other economic data prepared by federal statistical agencies.

Why were the revisions to the intial May and June estimates so large? The BLS states in each jobs report 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.” An article in the Wall Street Journal notes that: “Much of the revision to May and June payroll numbers was due to public schools, which employed 109,100 fewer people in June than BLS believed at the time.” The article also quotes Claire Mersol, an economist at the BLS as stating that: “Typically, the monthly revisions have offsetting movements within industries—one goes up, one goes down. In June, most revisions were negative.” In other words, the size of the revisions may have been due to chance.

Is it possible, though, that there was a more systematic error? As a number of people have commented, the initial response rate to the Current Employment Statistics (CES) survey has been declining over time. Can the declining response rate be the cause of larger errors in the preliminary job estimates?

In an article published earlier this year, economists Sylvain Leduc, Luiz Oliveira, and Caroline Paulson of the Federal Reserve Bank of San Francisco assessed this possibility. Figure 1 from their article illustrates the declining response rate by firms to the CES monthly survey. The figure shows that the response rate, which had been about 64 percent during 2013–2015, fell significantly during Covid, and has yet to return to its earlier levels. In March 2025, the response rate was only 42.6 percent.

The authors find, however, that at least through the end of 2024, the falling response rate doesn’t seem to have resulted in larger than normal revisions of the preliminary employment estimates. The following figure shows their calculation of the average monthly revision for each year beginning with 1990. (It’s important to note that they are showing the absolute values of the changes; that is, negative change are shown as positive changes.) Depite lower response rates, the revisions for the years 2022, 2023, and 2024 were close to the average for the earlier period from 1990 to 2019 when response rates to the CES were higher.

The weak employment numbers correspond to the period after the Trump administration announced large tariff increases on April 2. Larger firms tend to respond to the CES in a timely manner, while responses from smaller firms lag. We might expect that smaller firms would have been more likely to hesitate to expand employment following the tariff announcement. In that sense, it may be unsurprising that we have seen downward revisions of the prelimanary employment estimates for May and June as the BLS received more survey responses. In addition, as noted earlier, an overestimate of employment in local public schools alone accounts for about 40 percent of the downward revisions for those months. Finally, to consider another possibility, downward revisions of employment estimates are more likely when the economy is heading into, or has already entered, a recession. The following figure shows the very large revisisons to the establishment survey employment estimates during the 2007–2010 period.

At this point, we don’t fully know the reasons for the downward employment revisions announced yesterday, although it’s fair to say that they may have been politically the most consequential revisions in the history of the establishment survey.

Weaker Than Expected Jobs Report Shakes Up Investors’ Expectations of FOMC Rate Cuts

This morning (August 1), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for July. The data in the report show that the labor market was weaker than expected in July. There have been many stories in the media about firms becoming cautious in hiring as a result of the Trump administration’s tariff increases. Some large firms—including Microsoft, Walt Disney, Walmart, and Proctor and Gamble—have announced layoffs. In addition, real GDP growth slowed during the first half of the year. Nevertheless, until today it appeared that employment growth remained strong.

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

According to the establishment survey, there was a net increase of only 73,000 nonfarm jobs during July. This increase was below the increase of 1115,000 that economists surveyed by Factset had forecast. In addition, the BLS revised downward its previous estimates of employment in May and June by a combined 258,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure from the jobs report shows the net change in nonfarm payroll employment for each month in the last two years. The figure shows the striking deceleration in job growth during the second quarter of this year.

The unemployment rate increased from 4.1 percent in June to 4.2 percent in July, which is the same rate as economists surveyed had forecast. As the following figure shows, the unemployment rate has been remarkably stable over the past year, staying between 4.0 percent and 4.2 percent in each month since May 2024. In June, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.5 percent. The unemployment rate would have to rise significantly in the second half of the year for that forecast to be accurate.

Each month, the Federal Reserve Bank of Atlanta estimates how many net new jobs are required to keep the unemployment rate stable. Given a slowing in the growth of the working-age population due to the aging of the U.S. population and a sharp decline in immigration, the Atlanta Fed currently estimates that the economy would have to create 111,573 net new jobs each month to keep the unemployment rate stable at 4.2 percent. If this estimate is accurate, continuing monthly net job increases of 73,000 would result in a slowly rising unemployment rate.

As the following figure shows, the monthly net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. As measured by the household survey, there was a net decrease of 260,000 jobs in July, following an increase of 93,000 jobs in June. As an indication of the volatility in the employment changes in the household survey note the very large swings in net new jobs in January and February. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other, which was the case this month. (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 aged 25 to 54. In July the ratio declined to 80.4 percent from 80.7 percent in June. 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 November 2019. Further declines in the prime-age employment-population ratio would be a strong indication of a softening labor market.

It is still unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in federal government employment of 12,000 in June and a total decline of 84,000 since the beginning of February 2025. However, the BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.” It’s possible that as more federal employees end their period of receiving severance pay, future jobs reports may report a larger decline in federal employment. To this point, the decline in federal employment has been too small to have a significant effect on the overall labor market.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.9 percent in July, up from an increase of 3.8 percent in June.

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 July, the 1-month rate of wage inflation was 4.0 percent, up from 3.0 percent in June. If the July rate of wage inflation is sustained, it would complicate the Fed’s task of achieving its 2 percent target rate of price inflation. 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 Reserve’s policymaking Federal Open Market Committee (FOMC) with respect to setting its target for the federal funds rate? One indication of expectations of future changes in the FOMC’s target for the federal funds rate comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) Yesterday, as we noted in a blog post, investors assigned a 60.8 percent probability to the committee keeping its target unchanged at 4.25 percent to 4.50 percent at its September 16–17 meeting. As the following figure shows, there has been a sharp change in investors’ expectations. As of this morning, investors are assigning a 78.9 percent probability to the committee cutting its target by 0.25 percentage point (25 basis points) to a range of 4.00 percent to 4.25 percent.

There is a similarly dramatic change in investors’ expectations of the target range for the federal funds rate following the FOMC’s October 28–29 meeting. As the following figure shows, investors now assign a probability of 57.3 percent to the committee lowering its target range to 3.75 percent to 4.00 percent at that meeting. Yesterday, investors assigned a probability of only 13.7 percent to that outcome.

PCE Inflation Comes in Higher Than Expected

Image generated by ChatGTP-4o

Yesterday, in this blog post, we discussed the quarterly data on inflation as measured by changes in the personal consumption expenditures (PCE) price index. Today (July 31), the Bureau of Economic Analysis (BEA) released monthly data on the 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 June, headline PCE inflation was 2.6 percent, up from 2.4 percent in May. Core PCE inflation in June was 2.8 percent, unchanged from May. Headline PCE inflation was higher than the forecast of economists surveyed, while core PCE inflation was the same as 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 jumped from 2.0 percent in May to 3.4 percent in June. Core PCE inflation increased from 2.6 percent in May to 3.1 percent in June. So, both 1-month PCE inflation estimates are well above the Fed’s 2 percent 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 likely don’t capture fully the higher prices likely to result from the tariff increases the Trump administration has implemented, including those in trade agreements that have only been announced in the past few days.

Fed Chair Jerome Powell has frequently noted 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 June, up from 2.1 percent in May. Core market-based PCE inflation was 2.6 percent in June, up from 2.4 percent in May. So, both market-based measures show similar rates of inflation in June as the total measures do. In the following figure, we look at 1-month inflation using these measures. The 1-month inflation rates are both higher than the 12-month rates. One-month headline market-based inflation soared to 3.9 percent in June from 1.6 percent in May. One-month core market-based inflation also increased sharply to 3.6 percent in June from 2.2 percent in May. 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 rising significantly.

Is the increase in inflation attributable to the effects of tariffs? At this point, it’s too early to tell, particularly since, as noted earlier, all tariff increases have not yet been implemented. We can note, though, that 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 from 0.9 percent in May to 4.8 percent in June, while one-month inflation in services prices increased only from 2.5 percent in May to 2.8 percent in June.

Finally, we noted in a blog post yesterday that investors trading federal funds rate futures assigned a 55.0 percent probability to the Federal Open Market Committee leaving its target for the federal funds rate unchanged at its meeting on September 16–17. With today’s PCE report showing higher than expected inflation, that probability has increased to 60.8 percent.

The FOMC Leaves Its Target for the Federal Funds Rate Unchanged; Two B of G Members Dissent

Photo of President Trump and Fed Chair Powell from Reuters via the Wall Street Journal

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 and two members of the Board of Governors signalling that they were likely to dissent if the committee voted to hold its target constant.

Last week President Trump made an unusual visit to the Fed’s headquarters in Washington, DC to discuss what he had said was the Fed’s excessive spending on renovating three buildings. As we discuss in this blog post, the Supreme Court is unlikely to allow a president to remove a Fed chair because of disagreements over monetary policy. A president would likely be allowed to remove a Fed chair “for cause.” Some members of the Trump administration have argued that excessive spending on renovating buildings might be sufficient cause for the president to remove Fed Chair Jerome Powell. President Trump has indicated that, in fact, he doesn’t intend to replace Powell before his term as chair ends in May 2026, but President Trump still urged Powell to make substantial cuts in the federal funds rate target.

As most observers had expected, the committee decided today to keep its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent. Board of Governors members Michelle Bowman and Christopher Waller dissented, preferring “to lower the target range for the federal funds rate by 1/4 percentage point at this meeting.” It was the first time since 1993 that two members of the Board of Governors have voted against an FOMC decision.

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).)

In his press conference following the meeting, Chair Powell indicated that a majority of the committee believed that: “Inflation is above target, maximum employment is at target, so policy should be slightly restrictive.” Policy is restrictive in the sense that the current range for the federal funds rate is higher than the long-run equilibrium rate. Powell noted that: “There are many uncertainties left to resolve. There is much more to come looking ahead.” Jn particular, with respect to the effect of tariffs, he stated that it’s “still quite early days …. [We’ve] seen substantial increases in tariff revenue collections … [but we] have to see how much of tariffs are passed through to consumers. A long way to go to know what has happened.”

One reason that President Trump has urged the FOMC to lower its target for the federal funds rate is that lower interest rates will reduce the amount the federal government has to pay on the $25 trillion in U.S. Treasury debt owned by private investors. At his press conference, Chair Powell was asked whether the committee discussed interest payments on the national debt during its deliberations. He responded that the committee considers only the dual mandate of price stability and maximum employment given to the Fed by Congress. Therefore, “We don’t consider the fiscal needs of the federal government.”

The FOMC’s next meeting is on September 16–17. Powell noted that before that meeting, the committee will have seen two more employment reports and two more inflation reports. The data in those reports may clarify the state of the economy. There has been a general expectation that the committee would cut its target for the federal funds rate at that meting

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.) The data from the futures market indicate that one month ago investors assigned a 75.4 percent probability to the committee cutting its target range by 0.25 percentage point (25 basis points) to 4.00 percent to 4.25 percent at the September meeting. Today, however, sentiment has changed, perhaps because investors now believe that inflation in coming months will be higher than they had previously expected. As the following figure shows, investors now assign a 55.0 percent probability to the committee leaving its target for the federal funds rate unchanged at that meeting and only a 45 percent probability of the committee cutting its target range by 25 basis points.

Effect of Tariffs May Have Pushed Up CPI Inflation in June

Image generated by ChatGTP-4o

Today (July 15), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for June. 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 2.7 percent in June—up from 2.4 percent in May.
The core inflation rate, which excludes the prices of food and energy, was 2.9 percent in June—up slightly from 2.8 percent in May.

Headline inflation was slightly higher and core inflation was slightly lower than what economists surveyed had expected.

In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) surged from 1.0 percent in May to 3.5 percent in June. Core inflation (the red line) also increased sharply from 1.6 percent in May to 2.8 percent in June.

The 1-month and 12-month inflation rates are telling different stories, with 12-month inflation indicating that the rate of price increase is running moderately above the Fed’s 2 percent inflation target. The 1-month inflation rate indicates more clearly that inflation increased significantly during June.

Does the increase in inflation represent the effects of the increases in tariffs that the Trump administration announced on April 2? (Note that some of the tariff increases announced on April 2 have since been reduced) The following figure shows 12-month inflation in three categories of products whose prices are thought to be particularly vulnerable to the effects of tariffs: apparel (the blue line), toys (the red line), and motor vehicles (the green line). To make recent changes clearer, we look only at the months since January 2021. In June, prices of apparel fell, while the prices of toys and motor vehicles rose by less than 1.0 percent.

The following figure shows 1-month inflation in these prices of these products. In June, the motor vehicles prices fell, while apparel prices increased 5.3 percent and the prices of toys soared by 24.3 percent, which was the second month in a row of very large increases in toy prices.

The 1-month inflation data for these three products are a mixed bag with two of the products showing significant increases and one showing a decline. It’s likely that some of the effects of the tariffs are still being cushioned by firms increasing their inventories earlier in the year in anticipation of price increases resulting from the tariffs. As firms draw down their inventories, we may see tariff-related increases in the prices of more goods later in the year.

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 3.2 percent in June, up from 3.0 percent in May. Twelve-month median inflation (the red line) 3.6 percent in June, up from 3.5 percent in May.

The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation rose sharply from 2.2 percent in May to 3.9 percent in June. One-month median inflation also rose sharply from 2.7 percent in May to 4.1 percent in June. These data provide some confirmation that inflation likely rose from May to June.

What are the implications of this CPI report for the actions the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) may take at its next meetings? Investors who buy and sell federal funds futures contracts still expect that the FOMC will leave its target for the federal funds rate unchanged at its July 29–30 meeting before cutting its target by 0.25 (25 basis points) from its current target range of 4.25 percent to 4.50 percent at its September 16–17 meeting. (We discuss the futures market for federal funds in this blog post.) The FOMC’s actions will likely depend in part on the effect of the tariff increases on the inflation rate during the coming months. If inflation were to increase significantly, it’s possible that the committee would decide to raise, rather than lower, its target range.

Surprisingly Strong Jobs Report

Image generated by ChatGTP-4o

This morning (July 3), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for June. The data in the report show that the labor market was stronger than expected in June. There have been many stories in the media about businesspeople becoming pessimistic as a result of the large tariff increases the Trump Administration announced on April 2—some of which have since been reduced—and some large firms—including Microsoft and Walt Disney—have announced layoffs. In addition, yesterday payroll processing firm ADP estimated that private sector employment had declined by 33,000 in June. But despite these signs of weakness in the labor market, as the headline in the Wall Street Journal put it “Hiring Defied Expectations in June.”

According to the establishment survey, there was a net increase of 147,000 nonfarm jobs during June. This increase was above the increase of 1115,000 that economists surveyed had forecast. In addition, the BLS revised upward its previous estimates of employment in April and May by a combined 16,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”) The following figure from the jobs report shows the net change in nonfarm payroll employment for each month in the last two years.

The unemployment rate declined from 4.2 in May to 4.1 percent in June. Economists surveyed had forecast an increase in the unemployment rate to 4.3 percent. As the following figure shows, the unemployment rate has been remarkably stable over the past year, staying between 4.0 percent and 4.2 percent in each month since May 2024. In June, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate for 2025 would average 4.5 percent. The unemployment rate would have to rise significantly in the second half of the year for that forecast to be accurate.

Each month, the Federal Reserve Bank of Atlanta estimates how many net new jobs are required to keep the unemployment rate stable. Given a slowing in the growth of the working-age population due the aging of the U.S. population and a sharp decline in immigration, the Atlanta Fed currently estimates that the economy would have to create 113,500 net new jobs each month to keep the unemployment rate stable at 4.1 percent.

As the following figure shows, the monthly net change in jobs from the household survey moves much more erratically than does the net change in jobs from the establishment survey. As measured by the household survey, there was a net increase of 93,000 jobs in June, following a decrease of 696,000 jobs in May. As an indication of the volatility in the employment changes in the household survey note the very large swings in net new jobs in January and February. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. This month, the two surveys were consistent in both showing a net increase in employment. (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 aged 25 to 54—rose from 80.5 percent in May to 80.7 percent in June. The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is above what the ratio was in any month during the period from January 2008 to January 2020.

It is still unclear how many federal workers have been laid off since the Trump Administration took office. The establishment survey shows a decline in total federal government employment of 7,000 in June and a total decline of 69,000 since the beginning of February. However, the BLS notes that: “Employees on paid leave or receiving ongoing severance pay are counted as employed in the establishment survey.” It’s possible that as more federal employees end their period of receiving severance pay, future jobs reports may report a larger decline in federal employment. To this point, the decline in federal employment has been too small to have a significant effect on the overall labor market.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.7 percent in June, down from an increase of 3.8 percent in May.

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 June, the 1-month rate of wage inflation was 2.7 percent, down significantly from 4.8 percent in May. If the 1-month increase in AHE is sustained, it would indicate that the Fed may have an easier time achieving its 2 percent target rate of price inflation. But one month’s data from such a volatile series may not accurately reflect longer-run trends in wage inflation.

Before today’s jobs reports the signs that the labor market was weakening, which we discussed earlier, had led some economists and policymakers to speculate that a weak jobs report would lead the FOMC to cut its target range for the federal funds rate at its next meeting on July 29–30. That now seems very unlikely.

Are Stablecoins about to Become an Important Part of the U.S. Financial System?

Image illustrating stablecoins generated by ChatGTP4-o

Recently, U.S. Treasury Secretary Scott Bessent testified before Congress that the value of stablecoins could reach $2 trillion. In a post on X (formerly Twitter) he stated that “that stablecoins could grow into a $3.7 trillion market by the end of the decade.” Those amounts are far above the $250 billion estimated value of stablecoins in June 2025, yet still small relative to the value of M2—currently $21.9 trillion. But if the value of stablecoins were to rise to $2 trillion, that would be large enough to have a noticeable effect on the U.S. financial system.

As we discuss in Macroeconomics, Chapter 24 and in Money, Banking, and the Financial System, Chapter 2, stablecoins are a type of cryptocurrency—bitcoin is the best-known cryptocurrency—that can be bought and sold for a constant number of units of a currency, usually U.S. dollars. Typically, one stablecoin can be exchanged for one dollar.

Tether CEO Paolo Ardoino (photo from Bloomberg news via the Wall Street Journal)

Firms that issue stablecoins will redeem them in the underlying currency, which—as already noted—is nearly always the U.S. dollar. To make the promise to redeem stablecoins in dollars credible, firms that issue stablecoins hold reserve assets that are safe and highly liquid, such as U.S. Treasury bills or U.S. dollar bank deposits. Tether, which is headquartered in El Salvador, is the largest issuer of stablecoins, with about two-thirds of the market. As with bitcoins and other cryptocurrencies, stablecoins are stored and traded on public blockchains, which are decentralized networks of ledgers that record transactions. This system avoids the use of financial intermediaries—such as banks—which advocates for cryptocurrencies see as a key advantage because it eliminates the possibility that the intermediary might reject the transaction. But it also increases the appeal of stablecoins to people engaged in illegal activities.

Advocates for stablecoins believe that they can become a digital medium of exchange, which is a role that initially bitcoin was intended to play. The swings in the value of bitcoin turned out to be much larger than most people expected and made that crypto currency unsuitable for use as a medium of exchange. Stablecoins avoid this problem by keeping the value of the stablecoins fixed at one dollar. To this point, though, stablecoins have been primarily used to buy and sell bitcoin and other crypto currencies. As Federal Reserve Governor Christopher Waller put it in a speech earlier this year: “By their tie to the dollar, stablecoins are the medium of exchange and unit of account in the crypto ecosystem.” According to Waller, more than 80 percent of trading in cryptocurrencies is conducted using stablecoins.

One drawback to stablecoins is that firms that issue them charge a fee to redeem them. For instance, Tether requires that a minimum of $100,000 of stablecoins be redeemed and charges a fee of 0.1 percent of the amount redeemed with a minimum charge of $1,000. The redemption fee would be less important if stablecoins are used in large dollar transactions, such as occur in international trade. Advocates for stablecoins believe that they are particularly well suited for use in cross-border transactions because they don’t involve banks, as typically is necessary when firms buy or sell goods or services in foreign countries. The fees stablecoin issuers charge are generally lower than the fees banks charge for foreign exchange transactions.

The main source of profit for firms issuing stablecoins is the interest they earn on the assets they use to back the stablecoins they issue. Note, though, that firms issuing stablecoins have an incentive to buy riskier assets in order to increase the return on the stablecoins they issue. The incentives are similar to those banks face in investing depositors’ funds in assets that are riskier than the depositors would prefer. However, the risk that commercial banks take on is limited by bank regulations, which don’t yet apply to firms issuing stablecoins, although they may soon.

On June 17, the U.S. Senate moved to provide a regulatory framework for stablecoins by passing the Guiding and Establishing National Innovation for U.S. Stablecoins Act (Genius Act). The act requires that firms issuing stablecoins in the United States back them 100 percent with a limited number of reserve assets: dollar deposits in banks, Treasury securities that mature in 93 days or less, repurchase agreements backed by Treasuries (we discuss repurchase agreements in Macroeconomics, Chapter 15; Economics, Chapter 25; and Money, Banking, and the Financial System, Chapter 10), and money market funds that invest in eligible Treasury securities and repurchase agreements. Issuers of stablecoins will be subject to audits by U.S. federal regulators. To become law, the Genius Act must also be passed by the U.S. House and signed by President Trump.

Passage of the Genius Act would potentially provide a regulatory framework that would reassure users that the stablecoins they hold can be readily redeemed for dollars. Passage is also expected to lead some large retail firms, such as Walmart and Amazon, to issue stablecoins that could be used to make purchases on their sites. If enough consumers are willing to use stablecoins, these large retailers could save the fees they currently pay to credit card companies. In addition, stablecoin transactions can be cleared instantly, as opposed to the several days it can take for credit card payments to clear. Why would a consumer want to use stablecoin rather than a credit card to pay for something? Apart from the familiarity of using credit cards, the cards often provide rewards, such as points that can be redeemed for airline tickets or hotel stays. To attract consumers, stablecoin issuers would likely have to offer similar rewards to consumers who use stablecoins to make purchases.

As Waller notes, it will likely take years before consumers and firms routinely use stablecoins for day-to-day transactions. Today, very few retail firms are equipped to accept stablecoins and very few consumers own stablecoins.

Passage of the Genius Act would pose potential problems for Tether. Tether has held a wide range of reserve assets to back its stablecoins, including bitcoin and precious metals. It has also not been willing to be fully audited. Either Tether would have to change its business model to fit the requirements of the Genius Act or it would have to issue a separate stablecoin that would be used only in the United States and would meet the Genius Act requirements.

We noted earlier that Treasury Secretary Bessent believes that over the next few years, the value of stablecoins could increase to several trillions dollars. If that happens, the demand for Treasury securities would increase substantially as firms issuing stablecoins accumulated reserve assets. The result could be higher prices on Treasury securities and lower interest rates, which would eventually reduce the interest payments the Treasury makes on the federal government’s debt.

Finally, as we note in the text, Barry Eichengreen of the University of California, Berkeley as been a notable skeptic of stablecoins. As he wrote back in 2018, when the idea of stablecoins was just beginning to be widely discussed, when someone exchanges a dollar for a stablecoin, “one of us then will have traded a perfectly liquid dollar, supported by the full faith and credit of the U.S. government, for a cryptocurrency with questionable backing that is awkward to use. This exchange may be attractive to money launderers and tax evaders, but not to others.”

Could issuers of stablecoins be subject to runs like the one that led to the failure of Silicon Valley Bank in the spring of 2023?

In a recent opinion column in the New York Times, Eichengreen wrote that he is concerned about the possibility of runs on stablecoins. As we discuss in Macroeconomics, Chapter 14, and in Money, Banking, and the Financial Systems, Chapter 10, a commercial bank can be subject to a run if the bank’s depositors believe that the value of the bank’s assets are no longer sufficient to pay off the bank’s depositors. As we discuss in this blog post, Silocon Valley Bank experienced a run in the spring of 2023 that affected several other banks. Runs on commercial banks are unusual in the United States because of deposit insurance and the willingness of the Federal Reserve to act as lender of last resort to banks suffering liquidity problems. Eichengreen raises the question of whether stablecoins could experience runs if holders of the stablecoins come to doubt that the value of issuers’ reserve assets is sufficient to redeem all the coins.

Although the Genius Act provides for regulation of stablecoin issuers, Eichengreen believes that if enough firms begin issuing stablecoins, it’s likely that at some point one of them will experience a decline in the value of its reserve assets, which will cause a run. If the run spreads from one issuer to many in a process called contagion, stablecoin issuers will have to sell reserve assets, including Treasury securities. The result could be a sharp fall in the prices of those asset and an increase in interest rates. It’s possible that the outcome could be a wider financial panic and a deep recession. To head off that possibility, the Federal Reserve might feel obliged to intervene to save some, possibly many, stablecoin issuers from failing. The result could be that taxpayer dollars would flow to firms issuing stablecoins, which would likely cause a significant political backlash.

Many people see stablecoins as an exciting development in the financial system. But, as we’ve noted, there still remain some substantial roadblocks in the way of stablecoins becoming an important means of transacting business in the U.S. economy.