Key Points

  • Federal Reserve Chair Jerome Powell said Tuesday that the central bank faces growing risks of both higher inflation and higher unemployment, complicating its dual mandate from Congress to achieve stable prices and maximum employment.
  • "Inflation is above target and moving up modestly," Powell said after a speech to the National Association for Business Economics (NABE). At the same time, "there are quite clear downside risks to the labor market," he noted, adding that there is no "risk-free" path for easing monetary policy.
  • "If we move too quickly, we could fail on inflation and have to come back and deal with it later; if we move too slowly, the labor market could suffer unnecessary damage—painful damage," Powell said. "We are in a difficult place of balancing these two."

In-Depth Analysis

Powell hinted that the monetary tightening cycle may be nearing its end, saying the Fed could soon stop draining bank reserves from the financial system, i.e., pause the reduction of its $6.6 trillion balance sheet.

In 2020, at the onset of the pandemic's economic shock, the Fed restarted quantitative easing to stimulate borrowing, expanding its assets to nearly $9 trillion. In 2022, when the economy showed signs of stabilization, the Fed began shrinking its balance sheet by allowing bonds to mature without reinvestment each month.

"Our long-standing plan is to stop shrinking the balance sheet when reserve levels are slightly above what we consider consistent with an ample reserve regime," Powell said. "We may be approaching that level in the coming months, and we are closely monitoring a range of indicators to guide this decision."

Philadelphia Fed President Anna Paulson expressed concerns on Monday about the inflation and employment outlook, while signaling a preference for protecting the labor market through rate cuts in the remaining weeks of 2025.

"The August unemployment rate was 4.3%, close to what I consider full employment," Paulson said in a speech to NABE. "But the unemployment rate is above June's 4.1%, and the August jobs report shows downward momentum in the labor market." She added: "Labor market risks do seem to be increasing—not sharply, but clearly visible, and momentum seems to be heading in the wrong direction."

Given the softening labor market, policymakers made their first rate cut of the year last month, lowering the federal funds rate by 0.25 percentage points to a target range of 4% to 4.25%. Paulson said she agrees with the median forecast of Fed officials last month, which calls for 25-basis-point cuts at each of the two remaining policy meetings this year.

Since the federal government shutdown began earlier this month, Powell, Paulson, and other Fed officials have been considering adjusting monetary policy amid a lack of key federal data on the labor market, inflation, and other areas.

"In the employment area, there is some data available," Powell said, referring to state-level labor market data and ADP's monthly employment report. Still, "the alternative data we look at are better suited as supplements to government baseline data, which are the gold standard." Powell said that inflation and economic growth data currently provided by non-federal sources are less reliable than alternative labor market data.

Speaking about the shutdown and the prospect of no federal data in October, Powell said: "If this persists for a while, they won't be able to collect data, and it could become more challenging for policymakers."