Personal consumption expenditures (PCE) price index – HubbardOBrienEconomics.com Blog

Three Dissents as the FOMC Cuts Its Target for the Federal Funds Rate

Photo from federalreserve.gov

Today’s meeting of the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) had the expected result with the committee deciding to lower its target for the federal funds rate from a range of 3.75 percent to 4.00 percent to a range of 3.50 percent to 3.75 percent—a cut of 25 basis points. The members of the committee voted 9 to 3 in favor of the cut. Fed Governor Stephen Miran voted against the action, preferring to lower the target range for the federal funds rate by 50 basis points. President Austan Goolsbee of the Federal Reserve Bank of Chicago and President Jeffrey Schmid of the Federal Reserve Bank of Kansas City also voted against the action, preferring to leave the target range unchanged.

The following figure shows for the period since January 2010, the upper bound (the blue line) and the lower bound (the green line) for the FOMC’s target range for the federal funds rate, as well as the actual values for the federal funds rate (the red line). Note that the Fed has been successful in keeping the value of the federal funds rate in its target range. (We discuss the monetary policy tools the FOMC uses to maintain the federal funds rate within its target range in Macroeconomics, Chapter 15, Section 15.2 (Economics, Chapter 25, Section 25.2).)

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:

Compared with September, the committee members increased their forecasts of real GDP growth for each year from 2025 through 2027. The increase for 2026 was substantial, from 1.8 percent to 2.3 percent, although some of this increase was attributable to the federal government shutdown causing some economic output to be shifted from 2025 to 2026. Committee members slightly decreased their forecasts of the unemployment rate in 2027. They left their forecast of the unemployment rate in the fourth quarter of 2025 unchanged at 4.5 percent.
Committee members reduced their forecasts for personal consumption expenditures (PCE) price inflation for 2025 and 2026. Similarly, their forecasts of core PCE inflation for 2025 and 2026 were also reduced. The committee does not expect that PCE inflation will decline to the Fed’s 2.0 percent annual target until 2028.
The committee’s forecasts of the federal funds rate at the end of each year from 2025 through 2028 were unchanged.

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 by the 19 members of the value of the federal funds rate at the end of 2025. The fact that several members of the committee preferred that the federal funds rate end 2025 above 4 percent—in other words higher than it will be following the vote at today’s meeting—indicates that several non-voting district bank presidents, beyond Goolsbee and Schmid, would have preferred to not cut the target range. The plots on the far right of the figure indicate that there is substantial disagreement among comittee members as to what the long-run value of the federal funds rate—the so-called neutral rate—should be.

During his press conference following the meeting, Powell indicated that the increase in inflation in recent months was largely due to the effects of the increase in tariffs on goods prices. 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 the recent slow growth in employment, which he noted might actually be negative once the Bureau of Labor Statistics revises the data for recent months. This slow growth indicated that the risk of unemployment increasing was greater than the risk of inflation increasing. As a result, he said that 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 January 27–28. By that time a significant amount of new macroeconomic data, which has not been available because of the government shutdown, will have been released. 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 he declined at the press conference to say whether he will serve out the remainder of his term on the Board after he steps down as chair.) In addition, it’s possible that by the time of the next meeting the Supreme Court will have ruled on whether President Trump can legally remove Governor Lisa Cook from the Board and on whether President Trump’s tariff increases this year are Constitutional.

PCE Inflation Increases Slightly in September

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Today (December 5), the Bureau of Economic Analysis (BEA) released monthly data on the personal consumption expenditures (PCE) price index for September as part of its “Personal Income and Outlays” report. Release of the report was delayed by the federal government shutdown.

The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—with inflation measured as the percentage change in the PCE from the same month in the previous year. In September, headline PCE inflation was 2.8 percent, up slightly from 2.7 percent in August. Core PCE inflation in September was also 2.8 percent, down slightly from 2.9 percent in August. Both headline and core PCE inflation were equal to the forecast of economists surveyed.

Fed Chair Jerome Powell has frequently mentioned that inflation in non-market services can skew PCE inflation. Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices fall, the prices of financial services included in the PCE price index also fall. Powell has argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 2.6 percent in September, up from 2.4 percent in August. Core market-based PCE inflation was 2.6 percent in September, unchanged from August. So, both market-based measures show inflation as stable but above the Fed’s 2 percent target.

In the following figure, we look at 1-month inflation using these measures. One-month headline market-based inflation increase sharply to 3.7 percent in September from 2.6 percent in August. One-month core market-based inflation increased to 2.7 percent in September from 2.0 percent in August. 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.

Data on real personal consumption expenditures were also included in this report. The following figure shows compound annual rates of growth of real real personal consumptions expenditures for each month since January 2023. Measured this way, the growth in real personal consumptions expenditures slowed sharply in September to 0.5 percent from 3.0 percent in August.

Does the slowing in consumptions spending indicate that real GDP may have also grown slowly in the third quarter of 2025? Economists at the Federal Reserve Bank of Atlanta prepare nowcasts of real GDP. A nowcast is a forecast that incorporates all the information available on a certain date about the components of spending that are included in GDP. The Atlanta Fed calls its nowcast GDPNow. As the following figure from the Atlanta Fed website shows, today the GDPNow forecast—taking into account today’s data on real personal consumption expenditures—is for real GDP to grow at an annual rate of 3.5 percent in the third quarter, which reflects continuing strong growth in other measures of output.

In a number of earlier blog posts, we discussed the policy dilemma facing the Fed. Despite the Atlanta Fed’s robust estimate of real GDP growth, there are some indications that the labor market may be weakening. For instance, earlier this week ADP estimated that private sector employment declined by 32,000 jobs in November. (We discuss ADP’s job estimates in this blog post.) As the Fed’s policy-making Federal Open Market Committee (FOMC) prepares for its next meeting on December 9–10, it has to balance guarding against a potential decline in employment with concern that inflation has not yet returned to the Fed’s 2 percent annual target.

If the committee decides that inflation is the larger concern, it is likely to leave its target range for the federal funds rate unchanged. If it decides that weakness in the labor market is the larger concern, it is likely to reduce it target range by 0.25 percentage point (25 basis points). Statements by FOMC members indicate that opinion on the committee is divided. In addition, the Trump administration has brought pressure on the committee to cut its target 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.) Investors’ expectations have been unusually volatile during the past two months as new macroeconomic data or new remarks by FOMC members have caused swings in the probability that investors assign to the committee cutting the target range.

As of this afternoon, investors assigned a 87.2 percent probability to the committee cutting its target range for the federal funds rate by 25 basis points to 3.50 percent to 3.75 percent at its December meeting. At the December meeting the committee will also release its Summary of Economic Projections (SEP) giving members forecasts of future values of the inflation rate, the unemployment rate, the federal funds rate, and the growth rate of real GDP. 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.

Real GDP Growth Revised Up and PCE Inflation Running Slightly Below Expectations

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Today (September 26), the Bureau of Economic Analysis (BEA) released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report. Yesterday, the BEA released its revised estimate of real GDP growth in the second quarter. Taken together, the two reports show that economic growth remains realtively strong and that inflation continues to run above the Fed’s 2 percent annual target.

Taking the inflation report first, the following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2018, with inflation measured as the percentage change in the PCE from the same month in the previous year. In August, headline PCE inflation was 2.7 percent, up from 2.6 percent in July. Core PCE inflation in August was 2.9 percent, unchanged from July. Headline PCE inflation was equal to the forecast of economists surveyed, while core PCE inflation was slightly lower than forecast.

The following figure shows headline PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, headline PCE inflation increased from 2.0 percent in July to 3.2 percent in August. Core PCE inflation declined slightly from 2.9 percent in July to 2.8 percent in August. So, both 1-month and 12-month PCE inflation are telling the same story of inflation being well above the Fed’s target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure). In addition, these data likely reflect higher prices resulting from the tariff increases the Trump administration has implemented. Once the one-time price increases from tariffs have worked through the economy, inflation may decline. It’s not clear, however, how long that may take and President Trump indicated yesterday that he may impose new tariffs on pharmaceuticals, large trucks, and furniture.

Headline market-based PCE inflation was 2.4 percent in August, unchanged from July. Core market-based PCE inflation was 2.6 percent in August, also unchanged from July. So, both market-based measures show inflation as stable but above the Fed’s 2 percent target.

In the following figure, we look at 1-month inflation using these measures. One-month headline market-based inflation increase sharply to 2.5 percent in August from 0.9 percent in July. One-month core market-based inflation increased slightly to 1.9 percent in August from 1.8 percent in July. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate.

Inflation running above the Fed’s 2 percent target is consistent with relatively strong growth in real GDP. The following figure shows compound annual rates of growth of real GDP, for each quarter since the first quarter of 2023. The value for the second quarter of 2025 is the BEA’s third estimate. This revised estimate increased the growth rate of real GDP to 3.8 percent from the second estimate of 3.3 percent.

The most important contributor to real GDP growth was growth in real personal consumption expenditures, which, as shown in the following figure, increased aat compound annual rate of 2.5 percent in the second quarter, up from 0.6 percent in the first quarter.

High interest rates continue to hold back residential construction, which declined by a compound annual rate of 5.1 percent in the second quarter after declining 1.0 percent in the first quarter.

Business investment in structures, such as factories and office buildings, continued a decline that began in the first quarter of 2024.

Will the relatively strong growth in real GDP in the second quarter continue in the third quarter? Economists at the Federal Reserve Bank of Atlanta prepare nowcasts of real GDP. A nowcast is a forecast that incorporates all the information available on a certain date about the components of spending that are included in GDP. The Atlanta Fed calls its nowcast GDPNow. As the following figure from the Atlanta Fed website shows, today the GDPNow forecast is for real GDP to grow at an annual rate of 3.9 percent in the third quarter.

Finally, the macroeconomic data released in the last two days has had realtively little effect on the expectations of investors trading federal funds rate futures. Investors assign an 89.8 percent probability to the Federal Open Market Committee (FOMC) cutting its target for the federal funds rate at its meeting on October 28–29 by 0.25 percentage point (25 basis points) from its current range of 4.00 percent to 4.25 percent. That probability is only slightly lower than 91.9 percent probaiblity that investors had assigned to a 25 basis point cut a week ago. However, the probability of the committee cutting its target rate by another 25 basis points at its December 9–10 fell to 67.0 percent today from 78.6 percent one week ago.

Unusual FOMC Meeting Leads to Expected Result of Rate Cut

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).)

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.

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.

CPI Inflation Worsens, as Expected

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Today (September 11), the Bureau of Labor Statistics (BLS) released its report on the consumer price index (CPI) for August. The following figure compares headline CPI inflation (the blue line) and core CPI inflation (the red line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous year, was 2.9 percent in August, up from 2.7 in July.
The core inflation rate, which excludes the prices of food and energy, was 3.1 percent in August, up slightly from 3.0 percent in July.

Headline inflation and core inflation were both the same as economists surveyed had expected.

In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) jumped from 2.4 percent in July to 4.7 percent in August. Core inflation (the red line) increased from 3.9 percent in July to 4.2 percent in August.

The 1-month and 12-month inflation rates are both indicating that inflation accelerated in August. Core inflation—which is often a good indicator of future inflation—in particular has been running well above the Fed’s 2 percent inflation target during the last two months.

Of course, it’s important not to overinterpret the data from a single month. The figure shows that the 1-month inflation rate is particularly volatile. Also note that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI, to evaluate whether it is hitting its 2 percent annual inflation target.

Core inflation had been running significantly higher than headline inflation in the past few months because gasoline prices had generally been falling since February. Gasoline prices turned around in August, however, increasing at a 25.5 percent annual rate. As shown in the following figure, 1-month inflation in gasoline prices moves erratically—which is the main reason that gasoline prices aren’t included in core inflation.

Does the increase in inflation represent the effects of the increases in tariffs that the Trump administration announced on April 2? (Note that many of the tariff increases announced on April 2 have since been reduced) The following figure shows 12-month inflation in durable goods—such as furniture, appliances, and cars—which are likely to be affected directly by tariffs, and services, which are less likely to be affected by tariffs.. To make recent changes clearer, we look only at the months since January 2022. In August, inflation in durable goods increased to 1.9 percent from 1.2 percent in July. Inflation in services in August was 3.8 percent, unchanged from July.

The following figure shows 1-month inflation in the prices of these products, which may make the effects of tariffs clearer. In August, durable goods inflation was 5.1 percent up from 4.5 percent in July. Service inflation was 3.9 percent in August, down slightly from 4.0 percent in July. Inflation in goods and services both running well above 2 percent is not good news for inflation falling back to the Fed’s 2 percent target in the near future.

To better estimate the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates.
Trimmed-mean inflation drops the 8 percent of goods and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure shows that 12-month trimmed-mean inflation (the blue line) was 3.3 percent in August, up slightly from 3.2 July. Twelve-month median inflation (the red line) 3.6 percent in August, unchanged from July.

The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation rose from 2.9 percent in July to 3.2 percent in August. One-month median inflation remained unchanged at 3.4 percent in August. These data are consistent with the view that inflation is running above the Fed’s 2 percent target.

The CPI inflation data combined with the recent jobs data (which we discuss here and here), indicate that the U.S. economy may be entering a period of stagflation—a combination of rising inflation with falling, or stagnating, output. Stagflation poses a policy dilemma for the Fed’s policymaking Federal Open Market Committee (FOMC) because cutting its target for the federal funds rate to increase economic growth and employment may worsen inflation. At this point, it seems likely that the FOMC will “look through” this month’s rising inflation because it may be largely due to one-time price increases caused by tariffs. Committee members have signaled that they are likely to cut their target for the federal funds rate by 0.25 percent (25 basis points) at the conclusion of their meeting on September 16–17 and again at the conclusion of the following meeting on October 28–29.

PCE Inflation Is Steady, but Still Above the Fed’s Target

On August 29, the Bureau of Economic Analysis (BEA) released data for July on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.

The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2017, with inflation measured as the percentage change in the PCE from the same month in the previous year. In July, headline PCE inflation was 2.6 percent, unchanged from June. Core PCE inflation in July was 2.9 percent, up slightly from 2.8 percent in June. Headline PCE inflation and core PCE inflation were both equal to what economists surveyed had forecast.

The following figure shows headline PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, headline PCE inflation fell from 3.5 percent in June to 2.4 percent in July. Core PCE inflation increased slightly from 3.2 percent in June to 3.3 percent in July. So, both 1-month PCE inflation estimates are above the Fed’s 2 percent target, with 1-month core PCE inflation being well above target. The usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so we shouldn’t attempt to draw wider conclusions from one month’s data. In addition, these data may reflect higher prices resulting from the tariff increases the Trump administration has implemented. Once the one-time price increases from tariffs have worked through the economy, inflation may decline. It’s not clear, however, how long that may take and it’s likely that not all the effects of the tariff increases on the price level are reflected in this month’s data.

As usual, we need to note that Fed Chair Jerome Powell has frequently mentioned that inflation in non-market services can skew PCE inflation. Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices fall, the prices of financial services included in the PCE price index also fall. Powell has argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month headline inflation (the blue line) and 12-month core inflation (the red line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 2.3 percent in July, unchanged from June. Core market-based PCE inflation was 2.6 percent in July, also unchanged from June. So, both market-based measures show inflation as stable but above the Fed’s 2 percent target.

In the following figure, we look at 1-month inflation using these measures. One-month headline market-based inflation declined sharply to 1.1 percent in July from 4.1 percent in June. One-month core market-based inflation also declined sharply to 2.1 percent in July from 3.8 percent in June. As the figure shows, the 1-month inflation rates are more volatile than the 12-month rates, which is why the Fed relies on the 12-month rates when gauging how close it is coming to hitting its target inflation rate. Still, looking at 1-month inflation gives us a better look at current trends in inflation, which these data indicate is slowing significantly.

As we noted earlier, some of the increase in inflation is likely attributable to the effects of tariffs. The effect of tariffs are typically seen in goods prices, rather than in service prices because tariffs are levied primarily on imports of goods. As the following figure shows, one-month inflation in goods prices jumped in June to 4.8 percent, but then declined sharply to –1.6 in July. One-month inflation in services prices increased from 2.9 percent in June to 4.3 percent in July. Clearly, the 1-month inflation data—particularly for goods—are quite volatile.

Finally, these data had little effect on the expectations of investors trading federal funds rate futures. Investors assign an 86.4 percent probability to the Federal Open Market Committee (FOMC) cutting its target for the federal funds rate at its meeting on September 16–17 by 0.25 percentage point (25 basis points) from its current range of 4.25 percent to 4.5o percent. There has been some speculation in the business press that the FOMC might cut its target by 50 basis points at that meeting, but with inflation remaining above target, investors don’t foresee a larger cut in the target range happening.

In Jackson Hole Speech, Fed Chair Powell Signals a Rate Cut and Introduces the Fed’s Revised Monetary Policy Framework

Photo from federalreserve.gov

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.

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.

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.

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.

Real GDP Growth in the Second Quarter Comes in Higher than Expected

Image generated by ChatGTP-4o

This morning (July 30), the Bureau of Economic Analysis (BEA) released its advance estimate of real GDP for the first quarter of 2025. (The report can be found here.) The BEA estimates that real GDP increased by 3.0 percent, measured at an annual rate, in the second quarter—April through June. Economists surveyed had expected a 2.4 percent increase. Real GDP declined by an estimated 0.5 percent in the first quarter of 2025, so the increase in the second quarter represents a strong rebound in economic growth. The following figure shows the estimated rates of GDP growth in each quarter beginning with the first quarter of 2021.

As the following figure—taken from the BEA report—shows, the decrease in imports in the second quarter was the most important factor contributing to the increase in real GDP. During the first quarter, imports had soared as businesses tried to stay ahead of what were expected to be large tariff increases implement by the Trump Administration. Consumption spending increased in the second quarter, while investment spending and exports decreased.

It’s notable that real private inventories declined by $29.6 billion in the second quarter after having increased by $2070 billion in the first quarter. Again, it’s likely that the large swings in inventories represented firms stockpiling goods in the first quarter in anticipation of the tariff increases and then drawing down those stockpiles in the second quarter.

One way to strip out the effects of imports, inventory investment, and government purchases—which can also be volatile—is to look at real final sales to domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers increased by 1.2 percent in the second quarter of 2025, which was a decrease from the 1.9 percent increase in the first quarter. The large difference between the change in real GDP and the change in real final sales to domestic purchasers is an indication of how strongly the data on national income in the first two quarters of 2025 were affected by businesses anticipating tariff increases. Compared with data on real GDP, data on real final sales to domestic purchasers shows the economy doing significantly better in the first quarter and significantly worse in the second quarter.

The BEA report this morning included quarterly data on the personal consumption expenditures (PCE) price index. 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 the first quarter of 2018, with inflation measured as the percentage change in the PCE from the same quarter in the previous year. In the second quarter, headline PCE inflation was 2.4 percent, down slightly from 2.5 percent in the first quarter. Core PCE inflation in the second quarter was 2.7 percent, down from 2.8 percent in the first quarter. Both headline PCE inflation and core PCE inflation remained above the Fed’s 2 percent annual inflation target.

The following figure shows quarterly PCE inflation and quarterly core PCE inflation calculated by compounding the current quarter’s rate over an entire year. Measured this way, headline PCE inflation decreased from 3.7 percent in the first quarter of 2025 to 2.1 percent in the second quarter. Core PCE inflation decreased from 3.5 percent in the first quarter of 2025 to 2.5 percent in the secondt quarter. Measured this way, headline PCE inflation in the second quarter was close to the Fed’s target, while core PCE was well above the target. As we discuss in this blog post, tariff increases result in an aggregate supply shock to the economy. As a result, we may see a significant increase in inflation in the coming months as the higher tariff rates that have been negotiated recently begin to be implemented.