Federal Reserve – Inflation near 2%, Policy Adjustments Necessary to Avoid Recession

Federal Reserve Board Member, Christopher Waller, announced the time has come for monetary policy to be adjusted. Furthermore, Waller explained data indicates continued moderation in the labor market, with progress towards the Federal Open Market Committee’s (FOMC) 2% inflation goal. Therefore, according to Waller, it is time the FOMC’s focus should shift toward the employment side of the Federal Reserve’s dual mandate.

These statements from Waller echo earlier comments from Federal Reserve Chair Jerome Powell indicating the time has come for policy adjustments.

Cooling Inflation

The economic data for the first six months of 2024 showed a cooling economy, with the labor market moderating over the past year. Inflation rose in the first quarter but then retreated in the second, leading to a widespread belief that the FOMC was on track to achieve a “soft landing” in the second half of the year.

The recent jobs report indicated the possibility of a softening labor market alongside moderate economic growth. Furthermore, the balance of risks may be moving more towards downside risks to the FOMC’s maximum-employment mandate. Although the labor market has cooled, Waller believes the economy is not in a recession or headed for one soon. Instead, Waller summarized the labor market and economy are performing well, with prospects for continued growth and job creation. Lastly, Waller concluded with the belief the economy’s forward momentum will require reducing the target range for the federal funds rate.

Economy and Employment Ready for Federal Reserve Policy Adjustments

The economy and employment are expected to continue growing as inflation moves towards 2%. Evidence shows economic activity is growing at a steady pace, with GDP growing at a 2.2% annual rate in the first half of this year and continuing in the third quarter. Retail sales were stronger than expected in July, indicating healthy household spending.

The labor market is reportedly softening but not deteriorating, which is crucial for monetary policy decisions. Job openings in July showed a moderating labor market. Initial claims for unemployment insurance have risen gradually since January but have remained relatively low in the past two months.

The August jobs report showed a moderate labor market, with the unemployment rate dropping to 4.2% from 4.3% in July. The unemployment rate has increased steadily over the past 16 months, from 3.4% to 4.2%. Payrolls rose by 142,000 in August, but the three-month average payroll gain is still below the breakeven pace for job creation. July saw the first time the three-month average unemployment rate increased by at least a percentage point above its 12-month low.

Inflation has significantly decreased, with over 50% of categories having annualized monthly inflation below 2.5% in August. Core goods prices have reverted to a slight deflation pattern, reflecting normalized supply and technological advances. Services price inflation has slowed due to slowing wage growth. This progress towards the FOMC’s inflation goal is expected to continue throughout the year. Reducing the target range for the federal funds rate is recommended.

Series of Rate Cuts Expected

A series of reductions will be appropriate to address inflation and employment near long-term goals, with the labor market moderating. There is enough room to cut the policy rate while remaining restrictive to maintain inflation on the path to the 2% target. However, determining the appropriate pace for reducing policy restrictiveness will be challenging. A slower pace allows for a gradual assessment of the neutral rate, while a faster pace increases the likelihood of achieving a soft landing but may lead to overshooting on rate cuts if the neutral rate rises above pre-pandemic levels.

The FOMC’s decision to initiate rate cuts and reduce policy rates will be based on future data and economic conditions. The process should begin at the next meeting in September, and if the labor market deteriorates, the FOMC can swiftly adjust monetary policy. The size and pace of cuts will be determined by the data, not preconceived notions. If larger cuts are needed, they will be supported. The decisions will be influenced by new data and economic conditions. Although the cuts will be cautious, the FOMC is ready to act promptly to support the economy in the context of stable inflation.

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