A Commitment to Achieving Price Stability

The Federal Reserve System’s decentralized structure—with a Board of Governors in Washington, D.C., and 12 regional Reserve banks—allows monetary policy deliberations to incorporate input from around the country. While not every Federal Open Market Committee (FOMC) participant votes at each meeting, all seven members of the Board of Governors and all 12 Reserve bank presidents are at the table and share their views.

As interim president of the St. Louis Fed, I represent the Eighth Federal Reserve District at FOMC meetings, where I report on economic conditions in the District,The Eighth District includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. comment on key national economic data and analysis, and express my views on monetary policy. My views are informed by reports from contacts in various economic sectors throughout the District and the work of the economists at the St. Louis Fed.

In a Nov. 9 speech in Jeffersonville, Ind. (PDF), I discussed my views on recent economic conditions and monetary policy, as well as the FOMC’s commitment to achieving price stability. Some key points from my speech follow, along with updates based on data released since then.

The FOMC’s Response to Higher Inflation

The Federal Reserve has a mandate from Congress to pursue monetary policy directed toward achieving maximum sustainable employment and price stability. The FOMC judges that 2% average inflation, as measured by the personal consumption expenditures (PCE) price index, is consistent with the price stability goal.This numerical target for inflation is specified in the FOMC’s statement on longer-run goals and monetary policy strategy (PDF). The statement doesn’t specify a numerical target for the employment mandate because employment is influenced by many things besides monetary policy.

During the COVID-19 pandemic recession, the unemployment rate soared to 14.7% and inflation fell well below 2%, although it remained positive. The monetary policy response included lowering the target range for the federal funds rate to near zero and purchasing Treasury and mortgage-backed securities, thus expanding the Fed’s balance sheet.

As the economy recovered, the unemployment rate fell and inflation began to rise. Measured from a year earlier, headline PCE inflation reached a peak of 7.1% in June 2022, and core PCE inflation—which excludes food and energy prices—reached a peak of 5.6% in February 2022. In response to higher inflation, the FOMC has raised the federal funds rate target by 5.25 percentage points since March 2022 and has been reducing the size of the Fed’s balance sheet since June 2022.

PCE inflation has fallen significantly over the past year, but it is still well above the Fed’s 2% target, as shown in the chart below.The chart shows data available as of my Nov. 9 speech, and the dashed line indicates the Fed’s 2% inflation target. Economists expect that inflation will continue to fall. However, the inflation path has been bumpy. From July to September, headline PCE inflation stalled at 3.4%, while the core measure drifted down from 4.3% to 3.7% over that period. PCE inflation data for October are not yet available, but consumer price index (CPI) inflation declined in October.

While headline PCE inflation moved sideways in the third quarter, economic activity surged ahead. Third-quarter real gross domestic product (GDP) grew at an annualized rate of 5.2%—more than double the historical average. Similarly, payrolls rose sharply, with job gains averaging 233,000 per month in the quarter. In October, employment growth slowed to 150,000 jobs, and the unemployment rate ticked up to 3.9%.

Mismatch between Data and Anecdotes

One of the challenges when it comes to policymaking is that sometimes there is a mismatch between what the data indicate and what business contacts tell us about the economy. Economic data are inherently backward-looking, while information from contacts can sometimes suggest where inflation, the labor market and real GDP might be headed. Data reports and the insights from contacts in the community are both valuable inputs for policymakers, and sometimes information provided by our contacts reveals trends that only later show up in data reports.

For example, the number of jobs available for every unemployed person has declined from its peak value in 2022, but it has remained well above its historical level and indicative of a tight labor market. Ahead of the Oct. 31-Nov. 1 FOMC meeting, however, reports from our contacts in the Eighth District suggested that labor supply and demand were becoming better aligned, with firms telling us that it was easier to fill open positions now than it was a year ago and that wages weren’t rising as fast. We also heard from contacts that inflationary pressures seem to be easing.

The slowing of employment growth and the decline in CPI inflation in October illustrate the backward-looking nature of data reports and the value of talking to firms and others to get a better sense of the current state of the economy. The anecdotes that we at the St. Louis Fed received from our contacts prior to the last FOMC meeting suggested that those trends were occurring before the data reports were available.

Another development in the two or three months heading into the last FOMC meeting was that financial and credit conditions tightened. That tightening was reflected in higher yields on long-term Treasury and corporate securities, as well as in higher mortgage rates and other interest rates paid by households and firms. Reports at that time from throughout the Eighth District indicated that higher interest rates were beginning to constrain economic activity, which should dampen demand and put further downward pressure on inflation. However, there have been some declines in those yields and interest rates in recent weeks. It will be important to continue to monitor financial conditions to ensure they remain consistent with the FOMC’s goal of restoring price stability.

Avoid High Inflation Becoming Entrenched

On Nov. 1, in a decision I supported, the FOMC kept the policy rate unchanged while leaving the option of further tightening on the table in case it is needed to finish the job of restoring price stability. If progress toward achieving 2% inflation stalls, I believe that the FOMC should act promptly to ensure that high inflation does not become entrenched. If the American public comes to believe that high inflation will persist indefinitely, the resulting loss of credibility would make restoring price stability harder to achieve and entail greater economic costs.

I’m optimistic that price stability will be achieved, but we’re not quite there yet. Policymakers should not declare victory and release the monetary brake prematurely. Price stability is critical for achieving maximum sustainable employment and a strong economy. Therefore, it is important to remain vigilant until inflation is clearly and convincingly well on its way back to target.

Notes

1. The Eighth District includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.
2. This numerical target for inflation is specified in the FOMC’s statement on longer-run goals and monetary policy strategy (PDF). The statement doesn’t specify a numerical target for the employment mandate because employment is influenced by many things besides monetary policy.
3. The chart shows data available as of my Nov. 9 speech, and the dashed line indicates the Fed’s 2% inflation target.