Remarks as prepared for delivery.
Thank you ever so much for having me today. A pleasure it is to be among such distinguished company, alongside my fellow panelists.
As the New Year unfolds, it’s a splendid time to reflect on what the future may hold. I’d like to offer an overview of economic developments in the U.S. and highlight vital themes for monetary policy this year. Let me clarify, these are my personal views and not necessarily those of my colleagues on the Federal Open Market Committee (FOMC).
Inflation, dear friends, is where I’ll begin. Should I choose a motto for inflation in 2026, it would be “cautious optimism.” We have received some data as of November, though the lack of data collection during the government shutdown complicates matters. Hence, I focus on figures through September 2025.
Core Personal Consumption Expenditures (PCE) inflation held at 2.8 percent in September, mirroring the figure from a year prior. It might seem we’ve barely progressed. However, delving into the components reveals reasons for cautious optimism. Goods inflation has risen, yet is likely to normalize in the coming year.
Higher tariffs on imports are primarily causing this surge. Much of the price adjustment appears to have already unfolded. Producers may yet adjust prices further. January data will be pivotal, as firms naturally adjust prices at year’s start. I anticipate tariff-induced adjustments will largely affect goods, halting sustained inflation. By midyear, goods inflation should return to levels harmonizing overall inflation near 2 percent.
Encouragingly, core services inflation, excluding housing, eased from 3.5 percent to 3.3 percent over the year. It’s still elevated but trending favourably. Meanwhile, housing inflation has shown unambiguously positive news. From 5.1 percent, it’s dipped to 3.7 percent over a year.
Moreover, new market rents indicate further moderation, aligning with our inflation objectives for 2026. Thus, optimism prevails on inflation, aiming for a run-rate near 2 percent by year-end. While 12-month inflation remains slightly elevated, three-month inflation aims for 2 percent.
Monetary policy plays a supportive role here. I perceive the current funds rate as marginally restrictive. Past and present policy restrictiveness combined, should aid in aligning inflation to our target.
There’s progress on underlying inflation without broader inflation from tariff impacts. Long-term inflation expectations remain anchored, suggesting a steady return to a 2 percent goal. Labor market developments support this trend, speaking against the need for tighter monetary policy.
Now, let’s muse on output and employment. The theme for 2026 here is “waiting for clarity.” We face divergent signals in growth and the labor market. Third quarter GDP growth impressively hit 4.3 percent, yet the labor market is cooling.
Payroll growth dwindled, heavily relying on healthcare and social assistance. Large firms expanded, while smaller ones retracted. Supply and demand factors explain these shifts. Falling immigration thinned labor supply, while uncertainty curtailed hiring demand.
Topics such as trade policy and AI advancements contribute to this conundrum. Moreover, pandemic-era over-hiring dampens labor demand. Monetary restrictiveness adds to the mix. Demand appears slackened beyond supply, with unemployment tipping to 4.6 percent by November.
The labor market bends, yet doesn’t break. Unemployment insurance claims remained flat, though risks lurk, influencing my support for last year’s 75 basis point cuts. Close monitoring of labor shifts remains crucial.
Balancing strong growth with labor slowness prompts further contemplation. Could revised data harmonize these trends? History shows job gains may be adjusted downwards. When GDP and labor signals conflict, the labor insight often bears accuracy.
High consumption growth roots in high-income spending, the savings rate fell. Not everyone thrives, with low-income households facing economic pressures, despite a robust stock market. High-tech investment thrives, yet residential investment dampens under restrictive monetary policy.
A burgeoning productivity wave, led by AI and deregulation, might resolve discord between GDP and labor insights. Initial AI investments don’t require many workers. We could experience strong growth minus substantial job creation, as AI integration unfolds.
Such structural shifts challenge monetary policy. We can temper cyclical demand slowdowns, but structural labor demand changes are beyond policy repair. Growth drivers—cyclical or structural—remain elusive in real-time. Entry-level job deceleration might signal a cyclical downturn or an AI exposure forewarning.
A productivity bloom, if it arises, will precede clarity on driving forces. Policymakers wary of perceived above-trend growth inciting inflation should recall historical lessons. The FOMC’s patience under Chairman Greenspan in the 1990s amidst a tech boom bore fruits—booming GDP, unemployment dips, low inflation, and eventually, rate reductions.
Credibility underpinned by persistent inflation-fighting permits patience without inflation risk. As former Fed President McDonough aptly noted, credibility stems from pursuing policies encouraging stable prices and employment.
Thus, in 2026, themes of inflation optimism and awaiting growth clarity take precedence. Though labor risks exist, the expectation includes moderating inflation, stabilizing labor, and 2 percent growth. Such outcomes might necessitate modest funds rate tweaks later on.
Attention will remain on cyclical and structural economic influences, including AI, impacting labor market health, inflation progression, and monetary restrictiveness.
Time will reveal these factors’ impacts, guiding policy towards desired economic outcomes. Adhering to McDonough’s wisdom, we aim for decisions that embody the right course.
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