The Dual Mandate in Conflict: Balancing Current Tensions between Inflation and Employment

The two goals of the Federal Reserve’s dual mandate—maximum employment and stable prices—currently appear to be in conflict. The unemployment rate has been slowly, but steadily, increasing for the past two years. In January 2026, the unemployment rate reached 4.3%, higher than its April 2023 low of 3.4% though still below the historical average.For example, the average unemployment rate from 2012 to 2019 was 5.5%. Inflation, as measured by the 12-month change in the personal consumption expenditures (PCE) price index, has been persistently above the Fed’s 2% target since March 2021. In 2025, inflation was 2.9%, which is still well above target. The first figure below shows the evolution of these two variables since 2012, when the Fed started to explicitly target 2% inflation.

Given the sharp drop in inflation from its peak and perceived weakness in the labor market, the Federal Open Market Committee (FOMC) embarked on a series of interest rate reductions starting in September 2024. (See this blog post’s sixth figure, which tracks the federal funds rate over time.) Since September 2024, the federal funds rate has dropped 1.75 percentage points. At its January 2026 meeting, the FOMC stated that it is “attentive to the risks to both sides of its dual mandate” and decided “to maintain the target range for the federal funds rate at 3‑1/2 to 3‑3/4 percent.” As of this writing, futures markets assign near certainty to no change in the federal funds rate at the FOMC’s March meeting.

In this blog post, I will analyze the state of the dual mandate, the stance of monetary policy and the outlook for 2026 and beyond.

Prices and Inflation

As shown in the first figure, inflation in the era before the COVID-19 pandemic was, on average, below the Fed’s 2% target. The pandemic period witnessed a resurgence of high inflation: Annual PCE inflation crossed 2% in March 2021, peaked at 7.2% in June 2022, and dropped rapidly afterward. However, since 2023, inflation has hovered closer to 3% than 2%. Moreover, annual inflation has not dropped below target since March 2021.

As explained in a previous blog post, this pattern suggests that the pandemic caused a transition from a below-target inflation regime to an above-target inflation regime. The second figure shows the PCE price index excluding energy and identifies three periods, or inflation regimes.The price level is expressed as logarithmic differences from February 2020. Hence, the numbers on the vertical axis can be interpreted as approximations to percentage deviations since the start of the COVID-19 pandemic. It is an update of a figure presented in the previous blog post, which included data only through August 2025, and confirms the observations made then.

During the first regime, between 2012 and 2020, the price level grew at an average of 1.5% annually, which is below the Fed’s inflation target. The second regime, from 2021 to 2022, corresponds to the inflation surge during the pandemic, when prices grew 5.5% annually on average. In the third and current regime, which starts in 2023, prices have grown at an average pace of 2.7% annually.

Inflation in the above-target period—the third regime—is broad-based and not attributable to a few sectors or product categories. In 2025, roughly half of consumption expenditure was on product categories experiencing annual inflation over 3%. This share is double what it was, on average, in the prepandemic period.

Some of the more recent above-target inflation should be attributed to tariffs imposed on imported goods in 2025. Estimates of the impact of these tariffs on inflation vary widely.See this October 2025 blog post for estimates produced by St. Louis Fed economists. When inspecting the data, changes in the trends of the prices of durable goods and food are clearly visible. This suggests a simple calculation based on the difference between 2025 inflation rates for these product categories and those from a year earlier. One could also consider previous trends rather than monthly figures or incorporate the potential tariff impact on other product categories (such as nondurable goods). These various approaches provide a range of estimates for the contribution of tariffs to the price level: between 0.4 percentage points and 0.5 percentage points by December 2025. With inflation at 2.9%, this means that about half of the above-target inflation is attributable to tariffs. It also implies that without tariffs, inflation might have been closer to target, perhaps as low as 2.4%.

Labor Market

The labor market paints a less straightforward picture. As shown in the first figure, the unemployment rate reached a low of 3.4% in April 2023 and has been slowly but steadily increasing since then. However, it remains low by historical standards. In January 2026, the unemployment rate was 4.3%, well below the 2012-19 average of 5.5% and about the same as the 2016-19 average, when the labor market was deemed strong. Thus, if we were to focus only on the unemployment rate, we might characterize the labor market as having returned to normal rather than being weak or fragile.

Evidence for a weak labor market comes from looking at levels, not rates. As the third figure shows, growth in employment, as measured by total nonfarm payroll, has stalled.Nonfarm payroll is collected from the establishment survey by the Bureau of Labor Statistics. Employment as measured by the household survey provides a similar overall picture. Employment has been essentially flat since December 2024. A major contributor to this dynamic was the sharp contraction in immigration. Though estimates vary widely, they all point to significantly slower, even negative, net immigration for 2025. This implies a growth slowdown, perhaps even a contraction, in the immigrant population, labor force and employment.

The lack of a significant response in labor costs (e.g., as evidenced by the Employment Cost Index) suggests that a stalling labor supply was matched by similar dynamics on the demand side. The ongoing process of automation may have allowed firms to replace missing workers with capital (i.e., machines) and automated processes. An interesting counterfactual arises as to whether such a response by firms would have occurred in the absence of changes to immigration policy. If the answer is affirmative, then the unemployment rate would likely have risen sharply instead of mildly. On the other hand, a shortage of labor may have precipitated the adoption of new production methods.

One narrative appearing recently is that the economy is in a low-hiring, low-firing state. This would support the view that the labor market is fragile: Should layoffs increase (due to some adverse shock), firms would not hire at a fast enough rate and unemployment might shoot up. Again, this view depends on whether we look at levels or rates. The fourth figure shows hiring and firing rates (that is, total hires and total layoffs from the Job Openings and Labor Turnover Survey divided by total nonfarm payroll).

As we can see, the hiring rate has been dropping steadily since 2021, but it ended 2025 near—if a bit under—the historical average. The firing rate has been mostly flat, perhaps with a very small upward trend after 2021, but also remained slightly below the historical average at the close of last year. Thus, both the hiring and firing rates are slightly lower than their longer-term averages, though not significantly so.

The last labor market indicator we shall inspect is the ratio of job vacancies to unemployment. (See the fifth figure.) This indicator provides an estimate of how many job openings there are per unemployed person. However, this is a coarse measure, as it does not tell us whether those vacancies and unemployed people are suitably matched.

The job vacancies-to-unemployment ratio rose steadily until the COVID-19 pandemic hit, averaging 0.72 in the 2012-19 period. After dropping during the initial phase of the pandemic, the ratio peaked in early 2022, when there were about two job openings per unemployed person. The job vacancies-to-unemployment ratio decreased steadily after that and hovered around 1 from June 2024 until October 2025. It then started declining again. As of December 2025, the job vacancies-to-unemployment ratio was 0.87, below the prepandemic peak (and well below the postpandemic peak), but still high by historical standards. However, the drop in this ratio in recent months could be a source of concern.

The outlook for the labor market is somewhat cloudy. Employment levels have significantly stalled, driven by a dual contraction in immigration and firms’ labor demand. However, when focusing on relative indicators (e.g., the unemployment, hiring and firing rates), the labor market looks mildly worse than it was during its postpandemic peak, but still robust from a historical perspective. This may suggest a return to normal from a strong labor market rather than weakness.

Monetary Policy

With inflation significantly below its postpandemic peak, though still somewhat above target, and a weaker labor market, the FOMC embarked on a series of interest rate reductions starting in September 2024. At its last meeting, in January 2026, the FOMC decided to keep the federal funds rate unchanged.

The sixth figure shows the evolution of the federal funds effective rate and compares it with the 10-year Treasury yield, which is the basis for other market long-term rates. Despite the recent decline in short-term rates, long-term rates remain elevated. The 10-year Treasury yield has averaged 4.3% annually since July 2023, the last hike in the federal funds rate. This average for the 10-year Treasury yield is well above the 2012-19, prepandemic average of 2.3%. What explains this rise in long-term rates is a combination of higher expected inflation and higher real rates, plus possibly higher risk premia.For model decompositions of the 10-year Treasury yield, see the Cleveland Fed’s inflation expectations tool and this Fed paper on Treasury inflation-protected securities. These factors are driven, to a large extent, by the economic outlook and expectations about future fiscal and monetary policies.

What about the FOMC’s outlook for the future stance of monetary policy? Participants submitted their views for the December 2025 Summary of Economic Projections (SEP). The SEP is not a forecast, but rather a projection of relevant economic variables (GDP, unemployment and inflation) under appropriate monetary policy. Thus, it informs the public of where FOMC participants think the federal funds rate ought to be in the coming years.“Participants” here refers to the seven members of the Board of Governors plus the 12 regional Reserve bank presidents. However, FOMC “members,” who vote on the federal funds rate, include all seven governors, the president of the New York Fed, plus four regional bank presidents on a rotating schedule. Thus, there are 19 meeting participants but only 12 votes.

As we can see in the animated figure below, FOMC participants disagreed on the appropriate stance of monetary policy at their December meeting. The FOMC voted to reduce the federal funds rate target range to 3.5% to 3.75% (with a midpoint of 3.63%). A total of seven participants disagreed with this decision, according to their submitted projections. Six preferred to maintain the rate between 3.75% and 4%, and one participant indicated that the rate should be even lower, between 3.25% and 3.5%.In terms of actual votes, there were three dissents, two favoring no rate cut and one preferring a larger cut.

Projections for the appropriate federal funds rate at the end of 2026 vary widely, from a minimum of 2.13% to a maximum of 3.88%. That is, from a further 1.5 percentage point reduction to an increase of 0.25 percentage points. Disagreement about the appropriate federal funds rate persists in 2027 and 2028, though there is more concentration around the median, 3.13%.

In the longer run, FOMC participants have a wide range of views about the appropriate federal funds rate. Given the consensus target of 2% inflation, this variety of views implies disagreement about the appropriate longer-run real interest rate (commonly referred to as the neutral real rate or r-star). The median projection for the federal funds rate was 3%, with projections ranging from 2.63% to 3.88%. This amount of disagreement is not new. As a reference, in December 2019, right before the pandemic, the median projection for the longer-run federal funds rate was 2.5%, with individual submissions ranging from 2% to 3.25%. Thus, the range was the same (1.25 percentage points between the minimum and maximum projections), but the distribution in 2025 changed to the right, with the median projection increasing by 0.5 percentage points. The inflation target remains at 2%, which implies an increase in the median neutral real rate of 0.5 percentage points relative to the prepandemic period.

Outlook and Conclusions

The postpandemic period has been characterized by inflation persistently above the Fed’s 2% target. Despite the recent normalization in monetary policy, long-term interest rates remain elevated due to a combination of higher expected inflation and higher real rates. Perhaps the biggest risk now is the possibility that inflation remains in the current above-target regime and inflation expectations start drifting upward, away from the Fed’s target.

The labor market was very strong during the recovery from the COVID-19 recession but has since deteriorated somewhat. Employment growth has stalled recently, raising concerns of weakness or fragility in labor markets. Other indicators, most notably the unemployment rate, remain at historically healthy levels. So, there is a case to be made that the labor market has settled into a postpandemic normal, though risks to the downside remain.

The outlook for monetary policy remains uncertain, with varied views on the appropriate path for the federal funds rate. This disagreement is not new, as such divergence characterized FOMC participants’ views in the prepandemic period. However, participants’ views reflect a higher neutral real rate, matching the increase in market-based estimates of real rates.

For 2026 and beyond, the policy outlook is cloudy as the economy continues settling into a new postpandemic normal. In addition, policymakers need to factor in potential productivity gains due to AI and automation, fiscal policy, and potential innovations to bank regulation and balance sheet policy, among other considerations.

Notes

1. For example, the average unemployment rate from 2012 to 2019 was 5.5%.
2. The price level is expressed as logarithmic differences from February 2020. Hence, the numbers on the vertical axis can be interpreted as approximations to percentage deviations since the start of the COVID-19 pandemic.
3. See this October 2025 blog post for estimates produced by St. Louis Fed economists.
4. Nonfarm payroll is collected from the establishment survey by the Bureau of Labor Statistics. Employment as measured by the household survey provides a similar overall picture.
5. For model decompositions of the 10-year Treasury yield, see the Cleveland Fed’s inflation expectations tool and this Fed paper on Treasury inflation-protected securities.
6. “Participants” here refers to the seven members of the Board of Governors plus the 12 regional Reserve bank presidents. However, FOMC “members,” who vote on the federal funds rate, include all seven governors, the president of the New York Fed, plus four regional bank presidents on a rotating schedule. Thus, there are 19 meeting participants but only 12 votes.
7. In terms of actual votes, there were three dissents, two favoring no rate cut and one preferring a larger cut.