Reflections on Economic Challenges and Policy Evolution
As the Chair of the Federal Reserve, I stood before the audience to discuss the intricate balance of our economy, where inflation pressures and employment risks create a delicate dance that could tip into uncertainty at any moment.
This speech highlights the ongoing efforts to navigate these challenges while adapting our monetary policy framework for greater resilience.
TL;DR
The economy faces new hurdles from tariffs and immigration changes, making it hard to separate short-term fluctuations from lasting shifts.
Labor market growth has slowed, keeping unemployment stable but raising concerns about potential rapid downturns if risks materialize.
Inflation is easing in some areas but tariffs could spark new pressures, questioning whether these are temporary or lead to broader issues.
Monetary policy must balance employment and inflation risks, with adjustments based on data to maintain stability amid uncertainties.
Our policy framework evolves to handle diverse economic conditions, emphasizing adaptability without over-focusing on past constraints.
In my role at the Federal Reserve, I began by addressing the current economic landscape and our near-term policy outlook. One year ago, our policy rate was set at a restrictive 5.25 to 5.5% to curb inflation and achieve a sustainable balance between demand and supply. Inflation had neared our 2% target, but the unemployment rate had risen by nearly a full percentage point, a change typically seen only in recessions, signaling potential risks.
Over the past year, we adjusted our stance at three Federal Open Market Committee meetings to support a balanced labor market without excess slack. Now, the economy grapples with new challenges, including higher tariffs reshaping global trade and tighter immigration policies slowing labor force growth. These factors, along with possible changes in taxes, spending, and regulations, introduce significant uncertainty about future growth and productivity.
Distinguishing between cyclical and structural changes is crucial, as monetary policy can stabilize short-term fluctuations but not alter long-term trends. In the labor market, recent data shows payroll growth dropping to an average of 35,000 jobs per month over the last three months, down from 168,000 earlier in 2024, with revisions highlighting the slowdown's severity. Despite this, the unemployment rate remains low at 4.2%, and other indicators like layoffs and wage growth have softened only modestly, suggesting a delicate balance.
This balance arises from both supply and demand slowing, which could quickly lead to higher layoffs if downside risks escalate. Meanwhile, GDP growth has decelerated to 1.2% in the first half of the year, driven by weaker consumer spending, potentially reflecting slower potential output. On inflation, higher tariffs are pushing up prices in certain goods categories, with total PCE prices rising 2.6% and core PCE at 2.9% over the past 12 months.
Within core inflation, goods prices increased by 1.1%, a shift from previous declines, while housing services continue to ease and non-housing services remain slightly elevated. We anticipate tariff effects to build over time, but the key question is whether they will create a persistent inflation problem; our base case suggests they might be short-lived, though we must monitor for risks like wage-price spirals or shifting inflation expectations.
Turning to our monetary policy framework, it rests on our mandate to promote maximum employment and stable prices. We released a revised Statement on Longer Run Goals and Monetary Policy Strategy after a thorough review, building on the 2012 original. This year's review involved Fed Listens events, a research conference, and committee discussions, aiming to ensure the framework suits a wide range of conditions.
Past eras like the Great Depression or Great Inflation shaped our approach, and recent years highlighted rapid changes, such as the post-pandemic inflation surge that peaked at 40-year highs. We raised rates by 5.25 percentage points over 16 months to counter this, helping inflation move closer to target without a sharp unemployment rise. The revised statement removes emphasis on the effective lower bound, focusing instead on broad adaptability, and returns to flexible inflation targeting without a makeup strategy.
We stress the importance of anchored inflation expectations to support both mandate goals, recognizing that price stability benefits all Americans, especially those hit hardest by high costs. Changes also clarify our balanced approach when employment and inflation objectives conflict, considering the extent and timing of deviations from our goals.
Overall, our policy remains forward-looking, accounting for lags in its effects, and we continue to view 2% inflation as optimal for stability. We commit to reviewing the framework every five years to adapt to economic evolution, ensuring we can respond effectively to future challenges.
This ongoing refinement underscores the Federal Reserve's dedication to fostering a resilient economy, where lessons from the past inform our path forward without dictating it.
As we navigate these uncertainties, the evolution of our framework highlights the need for vigilance, ensuring that monetary policy supports sustainable growth and stability for generations to come.
Key Takeaways
Economic uncertainties from tariffs and immigration are complicating efforts to balance demand and supply dynamics.
The labor market shows signs of slowing but remains stable, with risks of rapid deterioration if not managed carefully.
Inflation is moderating in some areas but could face upward pressures, requiring close monitoring to prevent escalation.
Monetary policy adjustments aim to address both employment and inflation risks, guided by data and a flexible framework.
The revised policy strategy emphasizes adaptability across economic conditions, prioritizing anchored expectations and balanced mandates.
