How Will the Fed Balance Inflation and Jobs?

TL;DR

The Federal Reserve may adjust its restrictive policy stance because employment risks are rising even as tariffs create upward inflation risks. Powell said decisions are not preset and will depend on incoming data, the outlook, and the balance of risks. The revised monetary policy framework continues to prioritize maximum employment, stable prices, transparency, and effectiveness across varied economic conditions.

Transcript

labor market remains near maximum employment and inflation though still somewhat elevated has come down a great deal from its post-pandemic highs. At the same time, the balance of risks appears to be shifting. In my remarks today, I will first address the current economic situation and the near-term outlook for monetary policy. I will then turn to ... Read More

Key Insights

• The labor market is near maximum employment, but its apparent balance reflects marked slowdowns in both worker supply and worker demand. Average payroll growth fell to 35,000 per month over the three months through July, while unemployment remained historically low at 4.2%.
• Employment risks are increasingly tilted downward because weak job creation could develop rapidly into higher layoffs and unemployment. Quits, layoffs, vacancies relative to unemployment, and nominal wage growth had changed little or softened only modestly, providing no evidence of a large existing margin of labor-market slack.
• Economic growth slowed notably during the first half of the year, reaching a 1.2% pace compared with 2.5% in 2024. The slowdown largely reflected weaker consumer spending, although some weakness may also have resulted from slower growth in supply or potential output.
• Tariffs are visibly raising prices in some goods categories, with total PCE prices increasing 2.6% and core PCE prices increasing 2.9% over the 12 months ending in July. Core goods prices rose 1.1%, reversing the modest decline recorded during 2024.
• Tariff inflation may be a temporary shift in the price level, but its effects will not necessarily occur simultaneously. Price changes require time to pass through supply chains and distribution networks, while evolving tariff rates could extend the adjustment and increase uncertainty about timing and magnitude.
• Longer-term inflation expectations appear anchored and consistent with the Federal Reserve's 2% objective, despite inflation remaining above target for more than four years. Powell warned that stability cannot be assumed and pledged to prevent a temporary price increase from developing into continuing inflation.
• Monetary policy faces conflicting risks because inflation risks are tilted upward while employment risks are tilted downward. The policy rate remains restrictive but is 100 basis points closer to neutral than a year earlier, allowing officials to proceed carefully while considering a possible adjustment.
• The revised monetary policy framework preserves the congressional mandate of maximum employment and stable prices while seeking effectiveness across varied conditions. Its public review included Federal Reserve listening events, a research conference, staff analysis, and policymaker deliberations conducted through a series of FOMC meetings.

Questions & Answers

Q: Why might the Federal Reserve adjust its policy stance?

The Federal Reserve may adjust its policy stance because the baseline outlook and balance of risks have shifted while the policy rate remains restrictive. Employment risks are rising as payroll growth, labor-force growth, and economic growth slow. At the same time, tariffs are raising some prices and creating upside inflation risks. Officials therefore must balance both sides of the dual mandate rather than follow a preset path.

Q: What does the slowdown in payroll growth indicate?

Average payroll growth slowed to 35,000 jobs per month over the three months through July, down from 168,000 per month in 2024. The slowdown was larger than previously assessed because May and June figures were revised substantially lower. It has not yet created considerable labor-market slack, but it signals increasing employment risks that could appear quickly through sharply higher layoffs and unemployment.

Q: Why has unemployment stayed low despite weaker hiring?

Unemployment remained historically low at 4.2% because labor supply weakened alongside labor demand. Immigration fell sharply, labor-force growth slowed considerably, and labor-force participation edged down in recent months. These changes reduced the break-even pace of job creation needed to keep unemployment constant. Powell described the result as an unusual balance based on simultaneous weakness in worker supply and demand.

Q: How are tariffs affecting inflation and consumer prices?

Higher tariffs have begun increasing prices in some goods categories, and their effects on consumer prices are clearly visible. Core goods prices rose 1.1% over the 12 months ending in July, shifting from the modest decline seen during 2024. Further effects are expected as tariff increases move through supply chains and distribution networks, although their timing and size remain highly uncertain.

Q: Could tariff price increases cause persistent inflation?

A reasonable base case is that tariffs produce a relatively short-lived, one-time shift in the price level, although the adjustment may unfold gradually. Persistent inflation could arise if workers obtain higher wages after real incomes fall or if inflation expectations rise. Powell considered adverse wage-price dynamics less likely because the labor market is not especially tight and faces growing downside risks.

Q: What inflation indicators did Powell highlight?

Powell cited estimates showing total PCE prices rising 2.6% over the 12 months ending in July and core PCE prices rising 2.9%. Core goods prices increased 1.1%, housing services inflation remained on a downward trend, and non-housing services inflation stayed somewhat above a level historically consistent with 2% inflation. Longer-term inflation expectations nevertheless appeared anchored near the Federal Reserve's objective.

Q: How will the Federal Reserve make future rate decisions?

Future FOMC decisions will be based on officials' assessment of incoming data, its implications for the economic outlook, and the changing balance of risks. Monetary policy is not on a preset course. Because unemployment and other labor indicators remain relatively stable, officials can proceed carefully, but restrictive policy and increasing downside employment risks may justify changing the current stance.

Q: What changed in the Federal Reserve's policy framework review?

The revised framework continues to rest on the Federal Reserve's congressional mandate to pursue maximum employment and stable prices. The review sought to ensure that the strategy works across a broad range of economic conditions and evolves with structural changes and improved understanding. The process included regional listening events, a research conference, staff analysis, and policy discussions at multiple FOMC meetings.

Summary & Key Takeaways

• Economic growth and hiring weakened during the first half of 2025, but unemployment remained historically low at 4.2%. Powell characterized the labor market as an unusual balance created by simultaneous slowdowns in worker demand and labor supply, warning that employment risks could materialize quickly through higher layoffs and rising unemployment if conditions deteriorate further.

• Tariffs have begun raising goods prices, while housing services inflation continues to decline and non-housing services inflation remains somewhat elevated. Powell presented a temporary price-level increase as a reasonable base case but emphasized the possibility of persistent inflation through wage-price dynamics or unanchored expectations, risks the Federal Reserve intends to monitor carefully.

• The Federal Reserve remains committed to maximum employment and stable prices while considering whether its restrictive policy stance should change. Its revised framework seeks to work across diverse economic conditions, reflect evolving knowledge, and improve transparency and accountability. Future rate decisions will depend on data, the economic outlook, and competing mandate risks.