Photo from federalreserve.gov of the Pace University Fed Challenge team and their faculty advisers
Each year the Federal Reserve sponsors a competition among college student teams. As desribed on the Fed’s website, in the competition “Teams analyze economic and financial conditions and formulate a monetary policy recommendation, modeling the Federal Open Market Committee.”
This year’s winner is Pace University, representing the New York Federal Reserve District. Harvard College took second place and the University of California, Los Angeles took third place. The University of Pennsylvania, the University of Chicago, and Davidson College received honorable mentions. In 2024, the competition was won by the team from Princeton University, representing the Philadelphia Federal Reserve District.
This year, 139 colleges in 36 states participated in the competition. The rules of the competition are described here. After the competition, Federal Reserve Chair Jerome Powell noted that: “Fed Challenge offers undergraduate students an opportunity to learn firsthand about monetary policy and the work of the Federal Reserve. I thank these students for the dedication, creativity, and analytical skills they demonstrated as they grappled with real-world economic challenges.”
If not for the shutdown of the federal government, the Bureau of Labor Statistics (BLS) would have already released its “Employment Situation” report (often called the “jobs report”) for September and October by now. The September jobs report was released today based largely on data collected before the shutdown.
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.)
Because the household survey wasn’t conducted in October, the data in the October report that relies on the household survey won’t be included when the BLS releases establishment employment data for October on December 16. The data for September released today showed the labor market was stronger than expected in that month.
According to the establishment survey, there was a net increase of 119,00 nonfarm jobs during September. This increase was well above the increase of 50,000 that economists surveyed by FactSet had forecast. Economists surveyed by the Wall Street Journal had also forecast a net increase of 50,000 jobs. The relatively large increase in employment in September was partially offset by the BLS revising downward by a combined 33,000 jobs its previous estimates of employment in July and August. The estimate for August was revised from a net gain of 22,000 to a net loss of 4,000. (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 makes clear the striking deceleration in job growth beginning in May. The Trump administration announced sharp increases in U.S. tariffs on April 2. Media reports indicate that some firms have slowed hiring due to the effects of the tariffs or in anticipation of those effects.
As shown in the following figure, the unemployment rate increased from 4.3 percent in August to 4.4 percent in September, the highest rate since October 2021. The unemployment rate is above the 4.3 percent rate economists surveyed by FactSet had forecast. The unemployment rate had been remarkably stable, staying between 4.0 percent and 4.2 percent in each month from May 2024 to July 2025, before breaking out of that range in August. In September, the members of the Federal Open Market Committee (FOMC) forecast that the unemployment rate during the fourth quarter of 2025 would average 4.5 percent. The FOMC’s current estimate of the natural rate of unemployment—the normal rate of unemployment over the long run—is 4.2 percent. (We discuss the natural rate of unemployment in Macroeconomics, Chapter 9 and Economics, Chapter 19.)
Each month, the Federal Reserve Bank of Atlanta estimates how many net new jobs are required to keep the unemployment rate stable. Given slower growth in 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 111,878 net new jobs each month to keep the unemployment rate stable at 4.4 percent. If this estimate is accurate, if the average monthly net job increase from May through September of 38,600 were to continue, the result would be a 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 increase of 251,000 jobs in September, following a net increase of 288,000 jobs in August. 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. as was the case in September with employment increasing much more in the household survey than in the employment survey. (In this blog post, we discuss the differences between the employment estimates in the two surveys.)
The household survey has another important labor market indicator: the employment-population ratio forprime age workers—those aged 25 to 54. In September the ratio was 80.7 percent, the same as in August. The prime-age employment-population ratio is somewhat below the high of 80.9 percent in mid-2024, but is still above what the ratio was in any month during the period from January 2008 to February 2020. The continued high levels of the prime-age employment-population ratio indicates strength in the 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 3,000 in September and a total decline of 97,000 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 had only a small effect on the overall labor market.
The establishment survey also includes data on average hourly earnings (AHE). As we noted in this post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.8 percent in September, the same as in August.
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 September, the 1-month rate of wage inflation was 3.0 percent, down from 5.1 percent in August. This slowdown in wage growth may be an indication of a weakening labor market. But one month’s data from such a volatile series may not accurately reflect longer-run trends in wage inflation.
What effect might today’s jobs report have on the decisions of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) with respect to setting its target range for the federal funds rate? The minutes from the FOMC’s last meeting on October 28–29 indicate that committee members had “strongly differing views” over whether to cut the target range by 0.25 percentage point (25 basis points) at its next meeting on December 9–10 or to leave the target range unchanged.
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.) A month ago, investors assigned a 98.8 percent probability of the committee cutting its target range to 3.50 percent to 3.75 percent at its December meeting. Since that time indications have increased that output and employment growth have continued to be relatively strong and that inflation is stuck above the Fed’s 2 percent annual target. This morning, as the following figure shows, investors assign a probability of 60. 4 percent to the committee keeping its target unchanged at 3.75 percent to 4.00 percent at the December meeting. Committee members will also release their Summary of Economic Projections (SEP) at that meeting. The SEP, along with Fed Chair Powell’s remarks at his press conference following the meeting, should provide additional information on the monetary policy path the committee intends to follow in the coming months.
Kevin Hassett, director of the National Economic Council (photo from the AP via the Wall Street Journal)
Jerome Powell’s second term as chair of the Federal Reserve’s Board of Governor ends on May 15,2026. (Although his term as a member of the Board of Governors doesn’t end until January 31, 2028, Fed chairs have typically resigned their seats on the Board at the time that their term as chair ends.) President Trump has been clear that he won’t renominate Powell to a third term. Who will he nominate?
Polymarket is a site on which people can bet on political outcomes, including who President Trump will choose to nominate as Fed chair. The different amounts wagered on each candidate determine the probabilities bettors assign to that candidate being nominated. The following table shows each candidate with a probability of least 1 percent of being nominated as of 5 pm eastern time on October 27.
Kevin Hassett, who is currently the director of the National Economic Council, has the highest probability at 36 percent. Fed Governor Christopher Waller, who was nominated to the Board by President Trump in 2020, is second with a 23 percent probability. Kevin Warsh, who served on the Board from 2006 to 2011, and was important in formulating monetary policy during the financial crisis of 2007–2009, is third with a probability of 16 percent. Rick Reider, an executive at the investment company Black Rock, is unusual among the candidates in not having served in government. Bettors on Polymarket assign him a 10 percent probability of being nominated. Stephen Miran and Michelle Bowman are current members of the Board who were nominated by President Trump.
Scott Bessent is the current Treasury secretary and has indicated that he doesn’t wish to be nominated. James Bullard served as president of the Federal Reserve Bank of St. Louis from 2008 to 2023. David Zervos is an executive at the Jeffries investment bank and in 2009 served as an adviser to the Board of Governors. Lorie Logan is president of the Federal Reserve Bank of Dallas and Philip Jefferson is currently vice chair of the Board of Governors.
Today, Treasury Secretary Scott Bessent indicated that the list of candidates had been reduced to five—although bettors on Polymarket indicate that they believe these five are likely to be the first five candidates listed in the chart above, it appears that Bowman, rather than Miran, is the fifth candidate on Bessent’s lists. Bessent indicated that President Trump will likely make a decision on who he will nominate by the end of the year.
Fed Governor Christopher Wallace on October 21, 2025 at the Fed’s Payment Innovation Conference (photo from federalreserve.gov)
The current partial shutdown of the federal government has delayed the release by the Bureau of Labor Statistics (BLS) of its “Employment Situation” report (often called the “jobs report”). The report had originally been scheduled to be released on October 3. In a recent blog post we discussed how well the employment data collected by the private payroll processing firm Automatic Data Processing (ADP) serves as an alternative measure of the state of the labor market. In that post we showed that ADP data on total private payroll employment tracks fairly well the BLS data on total private employment from its establishment survey (often called the payroll survey) .
An article in today’s Wall Street Journal reports that ADP has stopped providing the Fed with early access to its data. Apparently, as a public service ADP had been providing its data to the Fed a week before the data was publicly released. The article notes that ADP stopped providing the data soon after this speech delievered by Fed Governor Christopher Wallace in late August. In a footnote to the speech Wallace refers to “data that Federal Reserve staff maintains in collaboration with the employment services firm ADP.” The article points out, though, that Waller’s speech was only one of several times since 2019 that a Fed official has publicly mentioned receiving data from ADP.
Losing early access to the ADP data comes at a difficult time for the Fed, given that the BLS employment data are not available. In addition, the labor market has shown signs of weakening even though growth has remained strong in measures of output. If payroll employment has been falling, rather than growing slowly as it was in the August jobs report, that knowledge would affect the deliberations of the Fed’s policymaking Federal Open Market Committee (FOMC) at its next meeting on October 28–29. Serious deterioration in the labor market could lead the FOMC to cut its target for the federal funds rate by more than the expected 0.25 percentage point (25 basis points).
In a speech in 2019, Fed Chair Jerome Powell noted that the Fed staff had used ADP data to develop a new measure of payroll employment. Had that measure been available in 2008, Powell argued, the FOMC would have realized earlier than it did that employment was being severely affected by the deepening of the financial crisis:
“[I]n the first eight months of 2008, as the Great Recession was getting underway, the official monthly employment data showed total job losses of about 750,000. A later benchmark revision told a much bleaker story, with declines of about 1.5 million. Our new measure, had it been available in 2008, would have been much closer to the revised data, alerting us that the job situation might be considerably worse than the official data suggested.”
The Wall Street Journal article notes that Powell has urged ADP to resume sharing its employment data with the Fed.
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.
Federal Reserve chairs often take the opportunity of the Kansas City Fed’s annual monetary policy symposium held in Jackson Hole, Wyoming to provide a summary of their views on monetary policy and on the state of the economy. In these speeches, Fed chairs are careful not to preempt decisions of the Federal Open Market Committee (FOMC) by stating that policy changes will occur that the committee hasn’t yet agreed to. In his speech at Jackson Hole today (August 22), Powell came about as close as Fed chairs ever do to announcing a policy change in a speech. In addition, Powell announced changes to the Fed’s monetary policy framework that had been in place since 2020.
Congress has given the Federal Reserve a dual mandate to achieve price stability and maximum employment. To reach its goal of price stability, the Fed has set an inflation target of 2 percent, with inflation being measured by the percentage change in the personal consumption expenditures (PCE) price index. In the statement that the FOMC releases after each meeting, it generally indicates the current “balance of risks” to meeting its two goals. In a press conference on July 30 following the last meeting of the FOMC, Powell stated that while the labor market appeared to be in balance at close to maximum employment, inflation was still running above the Fed’s 2 percent annual target.
In today’s speech, Powell stated that “the balance of risks appears to be shifting” and “that downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.” These statements seem to signal that he expects that at its next meeting on September 16–17 the FOMC will cut its target for the federal funds rate from its current range of 4.25 percent to 4.50 percent.
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, investors assigned a 75.0 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 at its September meeting. After Powell’s speech at 10 a.m. eastern time, the probability of a 25 basis point cut increased to 85.3 percent. As the following figure from the Wall Street Journa shows, the stock market also jumped, with the S&P 500 stock index having increased about 1.5 percent at 2:00 p.m. Investors were presumably expecting that by cutting its federal funds rate target, the FOMC would help to offset some of the current weakness in the labor market. (We discussed the weakness in the latest jobs report in this blog post.)
Powell also announced that the Fed had revised its monetary policy framework, which had been in place since 2020. The previous framework was called flexible average-inflation targeting (FAIT). The policy was intended to automatically make monetary policy expansionary during recessions and contractionary during periods of unexpectedly high inflation. If households and firms accept that the Fed is following this policy, then during a recession when the inflation rate falls below the target, they would expect that the Fed would take action to increase the inflation rate. If a higher inflation rate results in a lower real interest rate, there will be an expansionary effect on the economy. Similarly, if the inflation rate were above the target, households and firms would expect future inflation rates to be lower, raising the real interest rate, which would have a contractionary effect on the economy.
An important point to note is that with a FAIT policy, after a period in which inflation is below 2%, the Fed would aim to keep inflation above 2% for a time to “make up” for the period of low inflation. But the converse would not be true—if inflation runs above 2%, the Fed would attempt to bring the inflation back to 2%, but would not push inflation below 2% for a time to make up for the period of low inflation. The result is that, on average, the economy would run “hotter,” lowering the average unemployment rate over time. Many policymakers at the Fed believed that, in the years before 2019, the unemployment could have been lower without causing the inflation rate to be persistently above the Fed’s target.
With hindsight, some economists and policymakers argue that FAIT was implemented at just the wrong time. The policy was designed to address the problem of inflation running below the 2% target for most of the period between 2012 and 2019, resulting in unemployment being higher than was consistent with the Fed’s mandate for maximum employment. But, in fact, as the following figure shows, in 2020 the U.S. economy was about to enter a period with the highest inflation rates since the early 1980s.
In his speech today, Powell noted that:
“The economic conditions that brought the policy rate to the ELB [effective lower bound to the federal funds rate, 0 percent to 0.25 percent] and drove the 2020 framework changes were thought to be rooted in slow-moving global factors that would persist for an extended period—and might well have done so, if not for the pandemic. … In the event, rather than low inflation and the ELB, the post-pandemic reopening brought the highest inflation in 40 years to economies around the world.”
Powell outlined the key changes in the policy framework:
“First, we removed language indicating that the ELB was a defining feature of the economic landscape. Instead, we noted that our ‘monetary policy strategy is designed to promote maximum employment and stable prices across a broad range of economic conditions.'”
“Second, we returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy. As it turned out, the idea of an intentional, moderate inflation overshoot [after a period when inflation had been below the 2 percent annual target] had proved irrelevant. … Our revised statement emphasizes our commitment to act forcefully to ensure that longer-term inflation expectations remain well anchored, to the benefit of both sides of our dual mandate. It also notes that ‘price stability is essential for a sound and stable economy and supports the well-being of all Americans.’ “
“Third, our 2020 statement said that we would mitigate ‘shortfalls,’ rather than ‘deviations,’ from maximum employment. … [T]he use of ‘shortfalls’ was not intended as a commitment to permanently forswear preemption or to ignore labor market tightness. Accordingly, we removed ‘shortfalls’ from our statement. Instead, the revised document now states more precisely that ‘the Committee recognizes that employment may at times run above real-time assessments of maximum employment without necessarily creating risks to price stability.’ … [But] preemptive action would likely be warranted if tightness in the labor market or other factors pose risks to price stability.”
“Fourth, consistent with the removal of ‘shortfalls,’ we made changes to clarify our approach in periods when our employment and inflation objectives are not complementary. In those circumstances, we will follow a balanced approach in promoting them.”
“Finally, the revised consensus statement retained our commitment to conduct a public review roughly every five years.”
To summarize, the two key changes in the framework are: 1) The FOMC will no longer attempt to push inflation beyond its 2 percent goal if inflation has been below that goal for a period, and 2) The FOMC may still attempt to preempt an increase in inflation if labor market conditions or other data make it appear likely that inflation will accelerate, but it won’t necessarily do so just because the unemployment rate is currently lower than what had been considered consistent with maximum employment.
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.
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.
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.
Today (June 27), the BEA released monthly data 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 2016, with inflation measured as the percentage change in the PCE from the same month in the previous year. In May, headline PCE inflation was 2.3 percent, up from 2.2 percent in April. Core PCE inflation in May was 2.7 percent, up from 2.6 percent in April. Headline PCE inflation was equal to the forecast of economists surveyed, while core PCE inflation was slightly higher than forecast.
The following figure shows 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, PCE inflation increased in from 1.4 percent in April to 1.6 percent in May. Core PCE inflation also increased from 1.6 percent in April to 2.2 percent in May. So, both 1-month PCE inflation estimates are close to 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 announced on April 2.
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 2.1 percent in May, up from 1.9 percent in April. Core market-based PCE inflation was 2.4 percent in May, up from 2.3 percent in April. So, both market-based measures show similar rates of inflation in May 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 lower than the 12-month rates. One-month headline market-based inflation was 1.5 percent in May, down from 2.3 percent in April. One-month core market-based inflation was 2.1 percent in May, down from 2.7 percent in April. 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.
Earlier this week, the BEA released a revised estimate of real GDP growth during the first quarter of 2025—January through March. The BEA’s advance estimate, released on April 30, was that real GDP fell by 0.3 percent in the first quarter, measured at an annual rate. (We discussed the BEA’s advance estimate in this blog post.) The BEA’s revised estimate is that real GDP fell by 0.5 percent in the first quarter. The following figure shows the current estimated rates of real GDP growth in each quarter beginning in 2021.
As we noted in our post discussing the advance estimate, one way to strip out the effects of imports, inventory investment, and government purchases—which can all be volatile—is to look at real final sales to private domestic purchasers, which includes only spending by U.S. households and firms on domestic production. According to the advance estimate, real final sales to private domestic purchasers increased by 3.0 percent in the first quarter of 2025. According to the revised estimate, real final sales to private domestic purchasers increased by only 1.9 percent in the first quarter, down from 2.9 percent growth in the fourth quarter of 2024. These revised data indicate that economic growth likely slowed in the first quarter.
In summary, this week’s data provide some evidence that the inflation rate is getting close to the Fed’s 2 percent annual target and that economic growth may be slowing. Do these data make it more likely that the Fed’s policymaking Federal Open Market Committee (FOMC) will cut its target for the federal funds rate relatively soon?
Investors who buy and sell federal funds futures contracts still expect that the FOMC will leave its federal funds rate target unchanged at its next meetings on July 29–30 and September 16–17. Investors expect that the committee will cut its target at its October 28–29 meeting. (We discuss the futures market for federal funds in this blog post.) There remains a possibility, though, that future macroeconomic data releases, such as the June employment data to be released on July 3, may lead the FOMC to cut its target rate sooner.
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