What’s happening this week in economics?
US Federal Reserve acts and offers signals about the future
As expected, the Federal Reserve cut the benchmark interest rate by 25 basis points—the third such cut this year. Yet nothing else that happened was expected. First, the decision was not unanimous; rather, three of the 12 members of the Federal Open Market Committee (FOMC), which makes policy, dissented. There were two members who wanted to keep the rate unchanged, and one wanting to cut the rate by 50 basis points. There had not been three dissents in six years. Moreover, although the Fed signaled the possibility of another rate cut in 2026, given the president is expected to appoint a new Fed chair in 2026, this is uncertain. It is likely that the new appointee may favor a more rapid easing of monetary policy. Then the question will be whether the new chair can convince the other members of the FOMC to shift policy.
The Fed’s decision to cut the rate to between 3.5% and 3.75% was based on the view that the economy will see stronger grow in 2026 than previously expected and that inflation will be lower. Specifically, FOMC members offered their forecasts for growth and inflation. The median expected economic growth in 2026 stands at 2.3%, up from 1.8% in September. The median forecast for PCE-deflator inflation in 2026 is 2.4%, down from 2.6% in September.
In his press conference today, Fed Chair Jerome Powell said that “conditions in the labor market appear to be gradually cooling, and inflation remains somewhat elevated.” In other words, there is reason to be concerned about both employment and inflation. Yet, given that inflation is now expected to be a bit lower than previously anticipated, and given concern about job market conditions, the FOMC chose to cut the benchmark rate. On the other hand, the median forecast is that the Fed will only cut the rate once in 2026, suggesting that the committee remains concerned about inflation.
In his press conference, Powell noted that consumer spending and business investment continue to grow at a healthy pace. On the other hand, he pointed to weakness in the housing market as concerning. Powell also noted a sharp slowdown in employment growth. He said that “a good part of the slowing likely reflects a decline in the growth of the labor force, due to lower immigration and labor force participation, though labor demand has clearly softened as well. In this less dynamic and somewhat softer labor market, the downside risks to employment appear to have risen in recent months.”
On inflation, Powell said that the Fed did not have the necessary and up-to-date information due to the government shutdown. Still, available data indicated a largely tariff-driven acceleration in inflation. Yet tariffs mainly influence goods prices while Powell noted a deceleration in services inflation. That, in turn, might reflect the weakening labor market, especially as many services are labor-intensive.
Powell summarized the situation by saying that “risks to inflation are tilted to the upside and risks to employment to the downside—a challenging situation. There is no risk-free path for policy as we navigate this tension between our employment and inflation goals. A reasonable base case is that the effects of tariffs on inflation will be relatively short-lived—effectively a one-time shift in the price level. Our obligation is to make sure that a one-time increase in the price level does not become an ongoing inflation problem. But with downside risks to employment having risen in recent months, the balance of risks has shifted.”
Going forward, the Fed indicated that future decisions will depend on data. Perhaps the data of most interest will be the degree to which companies pass on the cost of tariffs to their customers. If they pass on the lion’s share of their increased costs, then inflation will rise significantly. If so, it will justify the Fed’s inclination to keep rates stable. On the other hand, a new chair will likely take a different view, given what we know about the US administration’s views on monetary policy. Historically, the FOMC has given considerable deference to the views of the chair. Yet if a new chair takes a radically different view, there could wind up being more division within the Fed. That, in turn, would create more uncertainty for investors trying to infer the future trajectory of policy.
Aside from cutting the benchmark interest rate, there are some other interesting aspects of Fed policy and organization worth noting:
First, in addition to the interest rate cut, the Fed announced that it will engage in US$40 billion in monthly purchases of short-term Treasury bonds. Previously, the Fed had been selling assets as part of an effort to reduce the size of its balance sheet. This quantitative tightening, as it came to be known, was effectively a tightening of monetary policy. Now that the Fed has shifted to easing policy, it made no sense to sell assets. The end of asset sales had been anticipated.
However, the large size of the asset purchases on which the Fed is now embarking was surprising to some observers. Still, Chair Powell said that this decision is not part of the monetary policy mix. Rather, it is meant to stabilize the country’s financial plumbing, especially given recent volatility in short-term funding markets. It will also help the Treasury to fund its massive sale of bonds to cover the budget deficit.
Second, although three members of the 12-member Federal Open Market Committee dissented on the decision to cut the benchmark interest rate by 25 basis points, there were four nonvoting regional Fed bank presidents who voted to keep rates unchanged. The FOMC comprises seven members of the Federal Reserve Board and five of the 12 regional Federal Reserve Bank presidents. The five always include the New York Fed president and four rotating presidents. The eight regional Fed presidents currently not serving on the FOMC can still express their views. And, in this case, four of them said no to an interest rate cut. This is significant because, over a short period of time, these presidents will return to the committee. It suggests the possibility of greater division among Fed policymakers going forward—especially if the president appoints a Fed chair next year who favors rapid easing of monetary policy.
Meanwhile, the US administration has indicated a preference for reducing the power of the regional Fed bank presidents. Yet, despite that, the seven-member board voted unanimously to approve the reappointment of 11 of the regional Fed bank presidents, with new terms beginning in March 2026. The regional Fed bank presidents are appointed by the commercial banks that are members of the Fed. The decision to approve the reappointment appears to reinforce the Fed’s independence but has likely set the stage for more division in the year to come.
Finally, in his press conference after the Fed’s announcement, Chair Powell said that the professional staff at the Fed believes that the government’s employment numbers are likely overstated. That is, the official numbers indicate faster employment growth than is actually taking place. Specifically, Powell said that, although the official data indicates recent average job growth of 40,000 jobs per month, the true number could be a loss of 20,000 jobs per month.
The reason for the difference has to do with the method used by the US Bureau of Labor Statistics (BLS). Given its lack of visibility regarding the creation or destruction of businesses, it guesses the number of jobs created or destroyed, based on a statistical model that often overestimates job creation, thereby leading to periodic downward revisions. The BLS plans to change the method in February, which could lead to more accurate numbers.
The significance of Powell’s remarks is that, if the Fed believes that job growth has been far worse than reported, it makes sense for the Fed to ease monetary policy.
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