– Can’t Ease Too Quickly, But Easing Too Slowly Would Mean ‘Painful” Job Losses
By Steven K. Beckner
(MaceNews) – Federal Reserve Chairman Jerome Powell avoided giving an overt signal about what the Fed will do with interest rates later this month, but clearly leaned toward greater concern about a softening labor market than about inflation in an eagerly awaited Tuesday speech.
Powell, speaking to the annual meeting of the National Association for Business Economics in Philadelphia. concentrated his prepared remarks on the Fed’s balance sheet and made limited comments on the economy and monetary policy.
But he did observe that “downside risks” to employment have increased, and he amplified on that point in response to questions. After saying the labor market has shown “pretty significant downside risks,” he added that it has “softened pretty considerably.”
Powell acknowledged that inflation remains above target, though rising only “gradually.” and said the Fed is “in the difficult situation of balancing those two things.”
“There is no risk-free path for policy as we navigate the tension between our employment and inflation goals,” he told the business economists.
Powell suggested the Fed must be careful in how it proceeds, because cutting rates “too quickly” could exacerbate inflation, but he also warned that if the Fed moves “too slowly” toward a “more neutral” monetary stance it could generate “painful losses” in the job market.
At the same venue Monday afternoon, new Philadelphia Federal Reserve Bank President Anna Paulson was more forthright in favors further monetary easing, albeit “cautiously.”
Powell was speaking two weeks ahead of an Oct. 28-29 meeting of the Fed’s policymaking Federal Open Market Committee, when an additional reduction in the federal funds rate is expected to be very much on the table.
At its last meeting, Sept. 16-17, the FOMC cut its policy rate by 25 basis points to a target range of 4.0% to 4.25%, after leaving it unchanged all year following 100 basis points of easing in the last three months of 2024.
In their revised quarterly Summary of Economic Projections, the 19 FOMC participants projected another 50 basis points of easing before the end of the year, which seems likely to take the form of a 25 basis point cut on Oct. 29 and another on Dec. 10, if Fed Gov. Christopher Waller’s recent commentary holds true. That would leave the funds rate at a median 3.6% (3.5% to 3.75%) — 60 basis points above the FOMC’s estimated 3% “longer run” “neutral” rate.
Fed officials are anything but united on the appropriate path of monetary policy, though. Further easing has received vocal support from Governors Michelle Bowman, Stephen Miran and Waller. New York Federal Reserve Bank President John Williams, the FOMC vice chairman, has also strongly suggested he will vote for additional cuts.
But other FOMC voters, including Vice Chairman Phillip Jefferson, Gov. Michael Barr and Boston Fed President Susan Collins, have been more ambiguous. And some, notably St. Louis Fed President Alberto Musalem and Kanssas City Fed Chief Jeffrey Schmid, have openly questioned whether more cuts are needed.
Powell was succinct about the economy and monetary policy in the text of a NABE speech devoted primarily to the quantitative aspects of policy.
He began by saying “the outlook for employment and inflation does not appear to have changed much since our September meeting four weeks ago,’ although he observed that data available prior to the government shutdown “how that growth in economic activity may be on a somewhat firmer trajectory than expected.”
Despite the upward trajectory of GDP, Powell noted that “payroll gains have slowed sharply” through August, and he added, “In this less dynamic and somewhat softer labor market, the downside risks to employment appear to have risen.”
Non-governmental data have shown that “both layoffs and hiring remain low, and that both households’ perceptions of job availability and firms’ perceptions of hiring difficulty continue their downward trajectories.”
Powell seemed somewhat less concerned about inflation, saying that “goods price increases primarily reflect tariffs rather than broader inflationary pressures.” And he noted that “most longer-term expectation measures remain aligned with our 2% goal.”
Assessing risks to the Fed’s two mandates, Powell said, “Rising downside risks to employment have shifted our assessment of the balance of risks,” and therefore the FOMC deemed it “appropriate to take another step toward a more neutral policy stance” in September.
He skirted the issue of what the FOMC will do on Oct. 29.
“There is no risk-free path for policy as we navigate the tension between our employment and inflation goals,” he said, adding, “We will set policy based on the evolution of the economic outlook and the balance of risks, rather than following a predetermined path.”
In response to questions, Powell continued to hew to the same basic cautious, data-dependent, risk management approach, but with a clear tilt toward toward job worries.
Asked if he is concerned that inflation might be more persistent if tariff hikes prove to have more than a one-time impact on the price level, the Fed chief replied, “that’s certainly a risk…”
“It appears inflation certainly is running above our target and appears to be continuing to increase — quite gradually, but increase,” he continued. “it’s still on the way up, so there’s a risk there that that would lend to greater persistence.”
However, Powell then shifted his focus to the ‘maximum employment” side of the Fed’s dual mandate, “But now the labor market has demonstrated pretty significant downside risks, as payroll jobs have declined.”
“Both supply and demand for labor have declined quite sharply,” he continued. “So those two states of affairs for our two goal variables call for different monetary policy responses.”
“So ….as they come more into balance I think the idea has been that policy should move from being tight to some degree to being more neutral as those two things balance out,” Powell went on. “But it is clear though that if we move too quickly then we may leave the inflation job unfinished and have to come back later and finish it.”
On the other hand, he added, “If we move too slowly there may be unnecessary losses, painful losses in the employment market.”
The Fed is “in the difficult situation of balancing those two things,” Powell said.
For much of the year, he recalled “we’ve been able to maintain a restrictive stance because the labor market was still pretty solid.”
But more recently, he said, data have shown that “the labor market has actually softened pretty considerably and puts us in a situation where the two risks are closer to being in balance,”
Powell acknowledged the “dispersion” of viewpoints on the FOMC, but said he considers the policy debate “healthy.”
Paulson, who succeeded Patrick Harker as president of the Fed’s Philadelphia-centered Third District on July 1 and who will be an FOMC voter next year, let it be known she will likely be a supporter of continued rate-cutting.
Weighing the balance of risks facing the Fed, she minimized inflation, while saying “momentum in the labor market is to the downside.” Her “base case is that tariffs will increase the price level, but they won’t leave a lasting imprint on inflation.” Therefore, “monetary policy should look through tariff effects on prices.”
Paulson. former Chicago Fed director of research, told the NABE she does not see “conditions as supporting problematic spillovers” of tariffs into inflation. Not only is a softening labor market dampening wage pressures, but firms are finding “creative ways to avoid passing on increased costs.” What’s more, “monetary policy is modestly restrictive and has been restrictive for some time.”
Hence, “I simply don’t see the type of conditions, especially in the labor market, which seem likely to turn tariff-induced price increases into sustained inflation,” she said.
Given that outlook, Pauslon said the Fed needs to be “moving policy towards a more neutral stance….(f)irst, because of the progress on underlying inflation, excluding the effects of tariffs,,,” and “(s)econd, labor market risks do appear to be increasing — not outrageously, but noticeably. And momentum seems to be going in the wrong direction.”
So she said the FOMC’s Sept. 17 rate cut “made sense,” and said she “view(s) easing along the lines of the median Summary of Economic Projections (SEP) policy path as appropriate,” i.e. 50 basis points of cuts that would take the median funds rate to 3.6%.
Paulson spoke somewhat more conditionally about fulfilling the SEP projection for 2026, which calls for another 25 basis points of easing to a median 3.4%.
“I see two important questions for monetary policy to grapple with in 2026,” she said. “The first question is: What is the neutral policy rate? And the second question is: How quickly should policy move to neutral?”
“My short answer to these questions is: I don’t know, and because I don’t know, we should proceed cautiously,” she continued, adding, “I think we will need to feel our way there, paying close attention to what economic developments tell us about the stance of policy.’
Paulson added that “the ability to go slowly and assess is particularly valuable as we get closer to neutral. We will be better positioned to go slowly in the future if we adjust policy in the near term in a way that better aligns labor market and inflation risks.”
In his prepared remarks on the balance sheet, Powell said the FOMC’s plan is “to stop balance sheet runoff when reserves are somewhat above the level we judge consistent with ample reserve conditions.”
“We may approach that point in coming months, and we are closely monitoring a wide range of indicators to inform this decision,” he continued. “Some signs have begun to emerge that liquidity conditions are gradually tightening, including a general firming of repo rates along with more noticeable but temporary pressures on selected dates.”
Powell said the FOMC will take a “deliberately cautious approach to avoid the kind of money market strains experienced in September 2019. Moreover, the tools of our implementation framework, including the standing repo facility and the discount window, will help contain funding pressures and keep the federal funds rate within our target range through this transition to lower reserve levels.”
He defended the “ample reserve” strategy the Fed has been pursuing since the finanncial crisis, saying it “has proven remarkably effective for implementing monetary policy and supporting economic and financial stability.”
Before speaking, Powell was awarded the NABE’s Adam Smith Award, previoius recipients of which include his predecessors Ben Bernanke and Janet Yellen.
NABE members are looking for further easing, but not exactlky as envisioned in the September SEP, according to a survey the organization released on Monday. They expect the funds rate to end this year at a median 3.865% and next year at 3.125%.
More than 72% of the business economists believe the funds rate is currently “calibrated just right.”
They disagreed on the neutral rate, with 55% agreeing with the FOMCs 3% estimate, while nearly a third put it above 3%, and 11% put it below 3%.