Jerome H. Powell, the chair of the Federal Reserve, is on the cusp of taking a big gamble with the U.S. economy.
He and his colleagues must soon decide which of two significant risks takes priority now that the Fed’s goals of low, stable inflation and high employment are in tension with each other. Inflation, still too high for the Fed’s liking, is rising again as businesses navigate President Trump’s global tariffs. The labor market also looks increasingly fragile, with monthly jobs growth slowing nearly to a halt this summer.
If the Fed puts more weight on the threat of resurgent price pressures and holds interest rates steady when it meets next month, that could raise the odds of an economic downturn. If the Fed instead moves to shore up the labor market by restarting interest rate cuts that were put on hold in January, inflation may be more likely to get stuck above the central bank’s 2 percent target.
Mr. Powell’s high-stakes balancing act will be on full display on Friday when he makes his final address as Fed chair to the world’s leading economic policymakers at the foothills of the Teton Range in Jackson, Wyo. His remarks over the past seven years have been the biggest draw of the three-day conference, which is set to kick off on Thursday. Hosted by the Federal Reserve Bank of Kansas City, it has for decades served as the top forum for central bankers, government officials and academics to debate pressing economic issues.
Since Mr. Powell’s most recent public appearance in late July, the prospect of an interest rate reduction in September has risen sharply as fears about the labor market have begun to overshadow lingering concerns over inflation. So has the White House’s pressure on the Fed to substantially lower borrowing costs. On Wednesday, the president expanded his attacks beyond Mr. Powell and called on Lisa Cook, a member of the Fed’s Board of Governors, to resign, citing unconfirmed allegations that she may have engaged in mortgage fraud.
This backdrop leaves Mr. Powell, whose term as chair ends in May, with the tall task of laying the groundwork for interest rate cuts without looking as if he is capitulating to Mr. Trump or turning prematurely sanguine on inflation. He could do that by suggesting the central bank can afford to reduce the degree of restraint it is imposing on the economy without going so far as to endorse outright easing.
“They’ve got multiple risks that they have to contend with,” said James Clouse, who served as deputy director of the Fed’s division of monetary affairs until May. “Exactly how they conduct policy in this environment is just very difficult and involves weighing the cost of inflation over the longer run versus the near-term costs of an economy that is weakening.”
Lessons From an Earlier Gamble
Cutting interest rates when inflation is moving in the wrong direction would not be the first gamble of Mr. Powell’s tenure as Fed chair. One of the most recent — and costly — was in 2021 when the central bank deemed pandemic-era inflation “transitory.”
That prognosis ended up being very wrong, with inflation soon surging to a four-decade high as red-hot demand collided with constrained supply chains. The Fed raised interest rates sharply and held them at a high level for an extended period to wrestle inflation back down to 2 percent, with appreciable success until Mr. Trump’s tariffs unleashed fresh price pressures. But the institution is still grappling with the fallout of its mistake.
One of the most tangible consequences is the gutting of a strategy, rolled out in 2020, that amounted to a revolution in the way the Fed set monetary policy when inflation was languishing and interest rates were close to zero. Mr. Powell is expected to elaborate on the proposed changes on Friday.
In practical terms, the 2020 framework meant the Fed would temporarily tolerate periods of higher inflation to make up for past stretches when it was too low. Officials would no longer raise interest rates just because joblessness was falling, but would wait to see price pressures climbing sustainably before taking action in a bid to maintain as robust a labor market as possible.
“In hindsight, it was a mistake,” said Raghuram Rajan, a former governor of the Reserve Bank of India. “This was a proactive measure to try and boost the effectiveness of the Fed’s armory, but unfortunately it came just when the problem changed.”
Mr. Powell has disputed that the new framework was to blame for the Fed’s delay in responding to the recent inflation spike. Current and former officials have also singled out overly prescriptive guidance that the central bank laid out before it would raise interest rates, which limited its ability to react swiftly when the economic backdrop suddenly shifted. Moreover, the Fed pledged to unwind an enormous government bond-buying program it had begun at the onset of the pandemic before taking any other policy action, which added to its delay.
William English, a Yale professor and a former director of the Fed’s division of monetary affairs, said the episode laid bare the costs of sticking to “commitment-like” guidance and exposed the shortcomings of a strategy that was too wedded to a specific environment. Charles Evans, who ran the Chicago Fed for 16 years until 2023, urged the central bank to adopt a “principles-based” framework that functioned more as a “timeless document.”
The Fed has signaled that it will revert to a more traditional inflation-targeting approach, rather than seeking to average 2 percent over time, and scrap language that suggested the Fed was chiefly concerned about unemployment when it was too high rather then being equally worried when it was too low. Mr. Powell on Friday may also preview potential changes to the way the Fed communicates its policy decisions and incorporates uncertainty amid a range of forecasts.
These changes are unlikely to have any bearing on how the Fed sets interest rates in the coming months. It is also unclear whether the new framework will survive the next chair of the Fed, whom Mr. Trump is actively searching for. He has already tapped a loyalist to fill a spot on the Board of Governors that Adriana Kugler abruptly vacated this month.
The top criterion for Mr. Trump’s pick is someone who will support lower borrowing costs, a pledge that has already raised questions about whether the central bank can uphold its independence from political interference.
The president wants interest rates that are around three percentage points lower than the current range of 4.25 percent to 4.5 percent. He has argued that the Fed’s failure to comply has unnecessarily held back the economy and made interest payments on the government’s debt much more costly.
A‘Wile E. Coyote’ Moment
No official at the Fed has backed such an aggressive reduction in interest rates — not even the two Trump-appointed members of the board who dissented on last month’s decision to hold interest rates steady, favoring a quarter-point cut instead. But support across the central bank appears to be building for borrowers to get some relief soon.
The argument rests in part on the worry that the labor market is on the verge of what Kris Dawsey, head of economic research at the D.E. Shaw Group, likens to a “Wile E. Coyote” moment — in which businesses suddenly start to shed workers and the economy nose-dives. Inflation stemming from tariffs has also so far been more contained than first feared.
So far, companies have opted to pull back on hiring as they have shelved big investments in the face of uncertainty about Mr. Trump’s policies. Businesses are also contending with a significantly smaller labor force because of the president’s immigration crackdown. The result has been a sharp slowdown in monthly jobs growth even as the unemployment rate has stayed relatively steady just above 4 percent.
This has created a conundrum for the Fed. If the recent pullback is simply a function of a declining supply of workers, that may suggest a response different from one driven by falling demand.
“In real time, the Fed can’t be sure of what’s really driving slower monthly jobs growth,” Mr. Dawsey said. “Even if you think that a lot of it is coming from a supply-side shock, you can’t be entirely certain of that, and you’ve got to be reacting in a way that’s putting some weight on the slowdown being driven by the demand side.”
He foresees the Fed cutting interest rates multiple times this year as officials shift toward a more “neutral” setting that neither boosts growth nor holds it back. Mr. Dawsey estimates that to be around 3.5 percent.
Another month of subdued jobs growth would help cement the case for a September cut, said Loretta Mester, whose 10 years as president of the Cleveland Fed ended in 2024. The central bank could frame it as “insurance” against the prospect that the labor market is indeed cracking, she added, while keeping interest rates high enough to temper any subsequent inflation stemming from tariffs.
The pace of cuts after that point will depend on how the economy evolves. Moderate inflationary pressures coupled with further signs that the labor market was deteriorating would most likely prod the Fed to act at successive meetings. The flip side could make the Fed move more slowly.
Fed’s Credibility on the Line
But the stakes are high if the Fed again misfires on inflation. Esther George, the president of the Kansas City Fed from 2011 to 2023, warned her former colleagues that it was “too soon to signal that your policy isn’t going to be aimed at bringing that inflation rate down.”
With stock markets near record highs, government bond yields easing and the unemployment rate low by historical standards, she questioned just how much restraint the Fed was inflicting on the economy. Further evidence that the labor market was under pressure would help to alleviate that concern, she said
But if cracks in the labor market do not deepen and heightened price pressures start to feed into expectations about future inflation, the Fed may face even more daunting circumstances, warned Mr. Clouse, who is now at the Andersen Institute for Finance and Economics.
“It can be very, very difficult to get inflation expectations reattached to 2 percent if they become detached, and it could require considerably tighter policy in the future than would otherwise be the case,” he said.
Perhaps the most detrimental outcome is one in which the Fed cuts interest rates and then soon has to reverse course.
“That’s a serious blow to credibility,” Mr. Rajan said. “You can wait and watch, but you can’t turn on a dime in terms of policy. That’s the prevailing mantra of central banks.”
Colby Smith covers the Federal Reserve and the U.S. economy for The Times.
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